FINANCIAL INSTRUMENTS

IND AS 32, 107, 109

Applicable from May 2016
By CA Sarthak Jain

WITH PRACTICAL
Mobile : 922 922 3040 *www.fast.edu.in
 First Attempt Success Tutorial

STANDARDS DEALING WITH FINANCIAL INSTRUMENTS UNDER IND AS

Under Ind AS, three Standards deal with accounting for financial instruments.
 Ind AS 32 Financial Instruments: Presentation deals with the presentation and classification
of financial instruments as financial liabilities or equity and sets out the requirements
regarding offset of financial assets and financial liabilities in the balance sheet.
 Ind AS 107 Financial Instruments: Disclosures sets out the disclosures required in respect of
financial instruments.
 Ind AS 109 Financial Instruments contains guidance on the recognition, derecognition,
classification and measurement of financial instruments, including impairment and hedge
accounting.

In this publication on Ind AS 32 and Ind AS 109, we deal with the classification, recognition and
measurement aspects of financial instruments.

At the outset, it may be noted that fair value of financial instruments should be determined in
accordance with the principles enunciated in Ind AS 113 Fair Value Measurement.

Financial Instruments
The definition of a financial instrument is broad. A financial instrument is defined as any contract
that gives rise to a financial asset of one entity and a financial liability or equity instrument of
another entity. Trade receivables and payables, bank loans and overdrafts, issued debt, equity and
preference shares, investments in securities (e.g. shares and bonds), and various derivatives are
just some of the examples of financial instruments. In addition, some contracts to buy or sell non-
financial items that would not meet the definition of financial instruments are specifically brought
within the scope of the financial instruments Standards on the basis that they behave and are used
in a similar way to financial instruments.

1. Financial assets
A financial asset is any asset that is:
 cash;
 an equity instrument of another entity;
 a contractual right:
to receive cash or another financial asset from another entity; or
to exchange financial assets or financial liabilities with another entity under
conditions that are potentially favourable to the entity; or
 a contract that will or may be settled in the entity’s own equity instruments under
certain circumstances.

Examples of financial assets are investments in equity instruments, investments in debt

instruments, trade receivables, cash and cash equivalents, derivative financial assets.

2. Financial liabilities
A financial liability is any liability that is:
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 a contractual obligation
to deliver cash or another financial asset to another entity; or
to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavourable to the entity; or
 a contract that will or may be settled in the entity’s own equity instruments under
certain circumstances.

It should be noted that the equity conversion option embedded in a convertible bond
denominated in foreign currency to acquire a fixed number of the entity’s own equity
instruments is an equity instrument if the exercise price is fixed in any currency. This is a
deviation from IAS 32 Financial Instruments: Presentation where a conversion option to
acquire a fixed number of equity shares for a fixed amount of cash in entity’s functional
currency only is treated as equity. Thus, a conversion option embedded in foreign
currency convertible bonds is treated as embedded derivative which is not the case
under Ind AS 32.

3. Equity
An equity instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all of its liabilities.

The presentation by the issuer of a financial instrument or its component parts as liability or
equity is determined based on principles of classification contained in Ind AS 32.

Principles of Liability/Equity Classification

A financial instrument or its component parts should be classified by the issuer upon initial
recognition as a financial liability or an equity instrument according to the substance of the
contractual arrangement, rather than its legal form, and the definitions of a financial liability and
an equity instrument. For some financial instruments, although their legal form may be equity, the
substance of the arrangements is that they are liabilities. A preference share, for
example, may display either equity or liability characteristics depending on the substance of the
rights attaching to it.

The appropriate classification as a financial liability, equity or a combination of both, is determined

by the entity when the financial instrument is initially recognised and that classification is not
generally changed subsequently unless the terms of the instrument change. As exceptions to this
general principle, there are certain circumstances in which reclassification may be appropriate
even though the terms of the instrument have not changed. In addition, when the specific
requirements for puttable instruments and instruments that contain an obligation to deliver a pro
rata share of net assets at liquidation no longer apply or start to apply, reclassification may be
appropriate.

When classifying a financial instrument in the consolidated financial statements, an entity should
consider all of the terms and conditions agreed upon between members of the group and the
holders of the instrument. For example, a financial instrument issued by a subsidiary could be

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classified as equity in the subsidiary’s individual financial statements and as a liability in the
consolidated financial statements if another group entity has provided a guarantee to make
payments to the holder of the instrument.

1. Contractual obligation to deliver cash or another financial asset

The key feature in determining whether a financial instrument is a liability is the existence
of a contractual obligation of one party (the issuer) to deliver cash or another financial asset
to another party (the holder), or to exchange financial assets or liabilities under conditions
that are potentially unfavourable. In contrast, in the case of an equity instrument (e.g.
ordinary shares) the right to receive cash in the form of dividends or other distributions is at
the issuer’s discretion and, therefore, there is no obligation to deliver cash or another
financial asset to the holder of the instrument. There is an exception to this rule for certain
puttable instruments and instruments with an obligation to deliver a pro rata share of net
assets only at liquidation.

Items such as deferred revenue and warranty obligations require delivery of goods or
services rather than an obligation to deliver cash or another financial asset and, therefore,
are not financial liabilities. Obligations to pay tax, company registration fees and other
similar charges are obligations to pay cash. However, these are statutory rather than
contractual requirements and, therefore, they are not financial liabilities. Similarly,
constructive obligations (as defined in Ind AS 37 Provisions, Contingent Liabilities and
Contingent Assets) do not arise from contracts and are not financial liabilities.

Liability characteristics are established in practice in a number of ways, as demonstrated

below.

 Mandatory redemption and/or mandatory interest payments

When an instrument requires mandatory redemption by the issuer for a fixed or

determinable amount, a contractual obligation to deliver cash at redemption exists
and, therefore, the instrument includes, and is presented as a liability. An exception
to this principle applies for certain puttable instruments and certain instruments that
contain an obligation to deliver a pro rata share of net assets at liquidation.

Example: Mandatorily redeemable preference shares

Entity A issues preference shares that are mandatorily redeemable at par in 10 years.
A contractual obligation to deliver cash exists for the repayment of principal - the
issuer cannot avoid the outflow of cash in Year 10. Therefore, the preference shares
should be classified as a financial liability.

Perpetual instruments provide the holder with no right to require redemption.

However, the terms of such instruments often require the issuer to make coupon
payments into perpetuity. A perpetual instrument with a mandatory coupon is a
liability in its entirety because the whole of its value is derived from the stream of
future coupon payments.

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Example: Perpetual coupon-bearing preference shares

A perpetual instrument is issued at a par amount of `100 million requiring coupon
payments of 8 percent to be made annually. Provided that 8 percent is the market
rate of interest for this type of instrument when issued, the issuer has assumed a
contractual obligation to make a future stream of 8 percent interest payments. The
net present value of the interest payments is `100 million and represents the fair
value of the instrument. The preference shares should be classified as a financial
liability.

Many traditional debt instruments such as bonds and bank loans involve both
mandatory redemption and interest payments.

Other instruments may require a mandatory distribution of a percentage of the

profits of an entity (to the extent that such profits are generated) rather than of a
traditional interest payment. Such an instrument meets the definition of a liability
because it is a contractual obligation of the issuer to deliver cash or another financial
asset to the holder. The issuer has no discretion over paying out a percentage of its
profits.

 Contractual obligation that is not explicit

An obligation may be established indirectly through the instrument’s terms and
conditions. Ind AS 32 gives two examples of how such an obligation could be created.
 A financial instrument may contain a non-financial obligation that must be settled
if, and only if, the entity fails to make distributions or to redeem the instrument.
If the entity can avoid a transfer of cash or another financial asset only by settling
the non-financial obligation, the financial instrument is a financial liability.
 A financial instrument is a financial liability if it provides that, on settlement, the
entity will deliver either cash or another financial asset, or its own shares whose
value is determined to exceed substantially the value of the cash or other
financial asset. Although the entity does not have an explicit obligation to deliver
cash or another financial asset, the holder of the asset has in substance been
guaranteed a minimum amount equal to at least the cash/ other financial asset
settlement option amount.

 Contingent settlement provisions

Financial instruments may be structured such that the obligation to deliver cash or
another financial instrument arises only on the occurrence or non-occurrence of
uncertain future events (or on the outcome of uncertain circumstances) that are
beyond the control of both the issuer and the holder of the instrument. The issuer
does not have an uncon- ditional right to avoid the obligation to deliver cash or
another financial instrument and, therefore, such instruments are financial liabilities
of the issuer unless:
 the contingent settlement provision that could require payment in cash or
another financial asset is not genuine; or
 settlement in cash or another financial asset can only be required in the event of
liquidation of the issuer; or

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 the instrument meets the specified criteria for a puttable instrument or an

obligation arising on liquidation to be classified as equity.

‘Genuine’ is generally understood to be not spurious or counterfeit, i.e. a genuine

provision is one that is authentic and has commercial substance. A provision that is
extremely rare, highly abnormal and very unlikely to occur is not considered genuine.

Future events that are beyond the control of both the issuer and the holder of the
instrument include:
 a change in macroeconomic, industry and other indices such as a stock market
index, consumer price index, growth in gross domestic product or total sector
production;
 changes in law, government regulations, and other regulatory requirements (such
as changes in taxation, pricing controls or accounting requirements); and
 changes in the key performance indicators of the issuer that are beyond the
control of both the issuer and the holder such as revenues, net income or debt to
equity ratio.

Example: Contingent settlement provisions: change in accounting or tax law

Entity A issues preference shares bearing 5 percent non-cumulative dividends that
are at the discretion of the issuer. The shares will be redeemed if the applicable
taxation or accounting requirements were to change.

The contingent event of a change in taxation or accounting requirements is deemed

to be genuine.

The requirement for redemption on change of taxation or accounting requirements

represents a contingent settlement provision (i.e. it is an uncertain future event
beyond the control of both the issuer and the holder of the instrument).

As the contingent event is genuine and can result in the issuer having to deliver cash
or another financial asset at a time other than the Entity A’s liquidation, the
instrument is classified as a financial liability.

However, the 5 percent dividend is at the discretion of Entity A and, consequently, is

equity of Entity A. Therefore, the preference share contain both debt and equity
features, i.e. it is a compound instrument.

2. Equity instruments
In classifying a financial instrument as a liability or equity, equity classification is appropriate
only if the instrument fails the definition of a financial liability as detailed above.

The key requirement in determining whether an instrument is equity is the issuer’s

unconditional ability to avoid delivery of cash or another financial asset. That ability is not
affected by:
 the history of making distributions;

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 an intention to make distributions in the future;

 a possible negative impact on the price of ordinary shares of the issuer if the
distributions are not made on the instrument concerned;
 the amount of the issuer’s reserves;
 an issuer’s expectations of a profit or loss for the period; or
 an ability or inability of the issuer to influence the amount of its profit or loss for the
period.

Provided that dividends are at the discretion of the issuer, it is irrelevant whether dividends
are cumulative or non-cumulative.

Once a dividend is properly declared and the issuer is legally required to pay it, a
contractual obligation to deliver cash comes into existence and a financial liability for the
amount of the declared dividend should be recognised. Similarly, a liability arises upon
liquidation to distribute to the shareholders the residual assets in the issuer, i.e. any
remaining assets after satisfying all of its liabilities.

The existence of an option whereby the issuer can redeem equity shares for cash does not
trigger liability classifica- tion because the issuer retains an unconditional right to avoid
delivering cash or another financial asset. A contractual obligation would only arise at the
point when the issuer exercised its right to redeem. This principle applies to all instruments
that are not derivatives over own equity.

Specific rules apply to derivatives over own equity. For example, a purchased call option
over a fixed number of shares will allow the issuer to buy back shares at a fixed price in the
future. The issuer always has a choice as to whether
it wishes to pay cash, because it always has a choice as to whether it wishes to exercise its
option. However, this instrument is only treated as equity if it is gross physically settled in
all cases when the issuer chooses to exercise, i.e. the option can never be net settled.

Instruments are frequently issued with a link to dividend payments on other types of
instruments, most commonly ordinary shares. A ‘dividend stopper’ is a contractual term
that requires no dividend to be paid on the ordinary shares if the payment is not made on
another specified instrument. A ‘dividend pusher’ is a term that requires a dividend to be
paid on a specified instrument if a dividend payment is made on ordinary shares.

Provided that the link is to the dividends on an instrument like an ordinary share where the
issuer has discretion as to whether or not to pay a dividend, neither a ‘dividend pusher’ or a
‘dividend stopper’ of itself result in the instrument concerned being classified as a liability.
This is because the issuer retains discretion as to whether or not to pay on the instrument,
albeit that the decision will need to be made in conjunction with the decision on whether to
pay dividends on ordinary shares. The issuer continues to have an unconditional right to
avoid the outflow of cash (or other financial assets).

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Compound Instruments
The terms of a financial instrument may be structured such that it contains both equity and liability
components (i.e. the instrument is neither entirely a liability nor entirely an equity instrument).
Such instruments are defined as compound instruments. An example of a compound instrument is
a bond that is convertible, either mandatorily or
at the option of the holder, into a fixed number of equity shares of the issuer. Compound
instruments come in many forms and are not restricted solely to convertible instruments. The
liability and equity components of a compound instrument are required to be accounted for
separately.

The requirement to separate out the equity and financial liability components of a compound
instrument is consistent with the principle that a financial instrument must be classified in
accordance with its substance, rather than its legal form. A compound instrument takes the legal
form of a single instrument, while the substance is that both a liability and an equity instrument
exist.

For example, a convertible bond that pays fixed coupons and is convertible by the holder into a
fixed number of ordinary shares of the issuer has the legal form of a debt contract; however, its
substance is that of two instruments:
 a financial liability to deliver cash (by making scheduled payments of coupon and principal)
which exists as long as the bond is not converted; and
 a written call option granting the holder the right to convert the bond into a fixed number of
ordinary shares of the entity.

The economic effect of the instrument is substantially the same as issuing simultaneously (i) a debt
instrument with an early settlement provision and (ii) warrants to issue ordinary shares.

1. Separating the liability and equity components

Separation of the instrument into its liability and equity components is made upon initial
recognition of the instrument and is not subsequently revised. The method used is as
follows:
 firstly, the fair value of the liability component is calculated, and this fair value
establishes the initial carrying amount of the liability component; and
 secondly, the fair value of the liability component is deducted from the fair value of the
instrument as a whole, with the resulting residual amount being recognised as the
equity component.

This method of allocating the liability and equity components is consistent with the
definition of equity as a residual interest in the assets of an entity after deducting all of its
liabilities. It ensures that no gain or loss arises on the initial recognition of the two
components.

The fair value of the liability component on initial recognition is the present value of the
contractual stream of future cash flows (including both coupon payments and redemption
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amount) discounted at the market rate of interest that would have been applied to an
instrument of comparable credit quality with substantially the same cash flows, on the
same terms, but without the conversion option.

Example: Convertible debt

Entity A issues 2,000 convertible bonds on 1 January 20X5. The bonds have a 3-year term,
and are issued at par with a face value of `1,000 per bond, resulting in total proceeds of `2
million. Interest is payable annually in arrears at an annual interest rate of 6 percent. Each
bond is convertible, at the holder’s discretion, at any time up to maturity into 250 ordinary
shares. When the bonds are issued, the market interest rate for similar debt without the
conversion option is 9 percent.

On initial recognition, the contractual cash flows of the liability component are valued first,
and the difference between the proceeds of the bond issue (being the fair value of the
instrument in its entirety) and the fair value of the liability is assigned to the equity
component. The present value (i.e. fair value) of the liability component is calculated using
a discount rate of 9 percent (i.e. the market interest rate for similar bonds with the same
credit
standing having no conversion rights). The calculation, which excludes the income tax
entries, is illustrated below.
Proceeds of bond issue (A) 2,000,000
Present value of principal at the end of 3 years* 1,544,367
Present value of interest (`120,000 payable annually in 303,755
arrears for 3 years**)
Total liability component (B) 1,848,122
Residual equity component (A-B) 151,878

*present value of principal amount at 9 percent:

2,000,000/(1.09)^3 = 1,544,367

** present value of interest (`120,000) payable at the end of each of 3 years:

interest at end of year 1: 120,000/1.09 = 110,092
interest at end of year 2: 120,000/(1.09)2 = 101,002
interest at end of year 3: 120,000/(1.09)3 = 92,661
Total net present value of interest payments 303,755

Upon initial recognition of the convertible instrument in the financial statements of the
issuer, the following entries are recorded
` `
Dr Cash 2,000,000
Cr Financial liability 1,848,122
Cr Equity 151,878
To recognise the recognition of convertible instrument.
Any transaction costs are allocated between the debt component and the equity
component using their relative fair values.

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The financial liability component will be subsequently measured in accordance with the
measurement requirements in Ind AS 109 depending on its classification (either as a
financial liability at FVTPL, or as an ‘other’ liability, measured at amortised cost using the
effective interest method).

The equity component will not be remeasured.

2. Separating the liability and equity components when the instrument has embedded
derivatives

In addition to the financial liability and equity components, a compound instrument may
also have embedded derivatives. For example, the instrument may contain a call option
exercisable by the issuer. The value of any such embedded derivative features must be
allocated to the liability component. Thus, the carrying amount of the liability component is
established by measuring the fair value of a similar liability (with similar terms, credit status
and embedded non-equity derivative features) but without an associated equity
component. The carrying amount of the equity component is then determined by
deducting the fair value of the liability component from the fair value of the compound
instrument as a whole.

A further assessment is required to establish whether the embedded derivative is closely

related to the liability component. This assessment is made before separating the equity
component. No gain or loss arises from initially recognising the components of the
instrument separately.

3. Early redemption of a compound instrument

When an entity redeems or repurchases a convertible instrument before its maturity

through a tender offer (without altering the conversion feature), the consideration paid
(including any transaction costs) is allocated to the liability and equity components at the
date of the early redemption/early repurchase. The method used to make this allocation is
the same as that used to make the original allocation of the proceeds of the issue of the
instrument between the liability and equity components upon initial recognition.

To the extent that the amount of the consideration allocated to the liability component
exceeds the carrying amount of the liability component at that time, a loss is recognised in
profit or loss. Conversely, to the extent that the consideration allocated to the liability
component is smaller than its carrying amount, a gain is recognised in profit or loss.

The amount of consideration allocated to equity is recognised in equity with no gain or loss
being recognised (the equity component that is not eliminated may be reclassified to
another line item within equity).

4. Treatment of mandatorily convertible instruments

An entity may issue an instrument that at the end of its life is mandatorily convertible into a
fixed number of its equity shares (rather than conversion being at the option of the holder).

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This instrument is, in substance, a prepaid forward purchase of the entity’s equity shares.
Because the instrument carries an obligation for the issuer to make fixed interest payments
during the life of the mandatorily convertible instrument, the instrument also includes a
financial liability component.

Treatment of Interest, Dividends, Gains and Losses and Other Items

The classification of a financial instrument or a component of a financial instrument as
either a financial liability or an equity instrument determines the treatment of interest,
dividends, and other gains and losses relating to that instrument or component of that
instrument. Interest, dividends, losses and gains relating to a financial liability, or to a
component of a compound instrument that is a financial liability, are recognised as income
or expense in profit or loss. Distributions to holders of equity instruments should be
recognised by the entity directly in equity. Similarly, transaction costs of an equity
transaction are accounted for as a deduction from equity. Income tax relating to
distributions to holders of an equity instrument and to transaction costs of an equity
transaction should be accounted for in accordance with Ind AS 12 Income Taxes.

The following items are treated as income or expense in profit or loss:

 interest payments on a bond issued by an entity;
 dividend payments on preference shares that are classified as financial liabilities;
 gains and losses associated with redemption or refinancing an instrument classified as a
financial liability (notwith- standing the fact that the instrument may take the legal form
of a share);
 gains and losses related to the carrying amount of an instrument that is a financial
liability notwithstanding the fact that the instrument gives the holder a right to
participate in the residual interest of an entity (e.g. certain puttable instruments such as
units in a mutual fund that fail equity classification); and
 costs of an equity transaction that is abandoned.

Dividends classified as an expense in profit or loss may be presented either with interest on
other liabilities or as a separate item.

Dividends that are non-discretionary represent a financial liability (or, depending on the
other terms of the shares, a component of a larger financial liability) to provide cash (or
another financial asset) to shareholders. In accordance with Ind AS 32, such dividends are
recognised as income or expense in profit or loss.

The obligation to pay non-discretionary dividends will be measured either at amortised cost
(using the effective interest method) or at fair value depending on the classification of the
financial liability to which the dividends relate. Unlike discretionary distributions to holders
of equity instruments, recognition does not depend on declaration of the dividend.

The following items are accounted for within equity:

 dividend payments on shares classified wholly as equity; and

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 incremental directly attributable costs incurred in successfully issuing or acquiring an

entity’s own equity instru- ments (including transaction costs, regulatory fees, amounts
paid to regulatory, legal, accounting and other profes- sional advisers, printing costs,
stamp duties).

The amount of transaction costs accounted for as a deduction from equity in the period is
disclosed in line with the requirements of Ind AS 1 Presentation of Financial Statements. Ind
AS 32 does not specify where in equity the transaction costs should be recognised and will
depend upon regulatory requirements if any.

Transaction costs that are incremental and directly attributable to the issue of a compound
financial instrument (i.e. they would have been avoided if the compound instrument had
not been issued) are allocated to the liability and equity components in proportion to the
allocation of the proceeds. Cost that relate jointly to more than one transaction (for
instance a joint and concurrent offering of some equity instruments and an issue of
instruments classified as liabilities) are allocated using a basis that is rational and consistent
with similar transactions.

Example : Transaction costs: placing and new issue of shares

Entity B places its privately held ordinary shares that are classified as equity with a stock
exchange and simul- taneously raises new capital by issuing new ordinary shares on the
stock exchange. Transaction costs are incurred in respect of both transactions. Because the
issue of new shares is the issue of an equity instrument, but the placing of the existing
equity instruments with the exchange is not, the transaction costs will need to be allocated
between the two transactions. Transaction costs in respect of the new shares issued will be
recognised in equity whereas the transaction costs incurred in placing the existing shares
with the stock exchange will be recognised in profit or loss.

Financial Assets and Financial Liabilities - Initial Recognition

An entity should recognise a financial asset or a financial liability in its balance sheet when, and
only when, the entity becomes party to the contractual provisions of the instrument and also
classify the same according to measurement basis.

Examples of initial recognition of arrangements as financial assets and financial liabilities are:
 Unconditional receivables and payables are recognised as assets or liabilities when the
entity becomes a party to the contract and, as a consequence, has a legal right to receive or
a legal obligation to pay cash.
 Issued debt is recognised as a liability when the entity that issues it becomes a party to the
contractual terms of the debt and, consequently, has a legal obligation to pay cash to the
debt holder.
 A derivative is recognised as an asset or a liability on the commitment date, rather than on
the date on which settlement takes place. At inception, the fair values of the right and
obligation created by the derivative may be equal in which case the fair value of the
derivative will be zero.

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Arrangements that are not recognised as financial assets and financial liabilities are:
 Planned future transactions, no matter how likely, are not assets and liabilities because the
entity has not become a party to a contract.
 Derivative contracts to buy or sell non-financial items that are scoped out of Ind AS 109 are
not recognised as financial assets and financial liabilities because they are executory
contracts.
 Assets to be acquired and liabilities to be incurred as a result of a firm commitment to
purchase or sell goods or services are generally not recognised until at least one of the
parties has performed under the agreement.

Under Ind AS 109, a ‘regular way’ purchase or sale of financial assets can be recognised (and
derecognised) using either ‘trade date accounting’ or ‘settlement date accounting’.

1. Financial assets and liabilities - initial measurement

Ind AS 109 requires that a financial asset (except for certain trade receivables) or a financial
liability should be measured at initial recognition at its fair value plus or minus, for financial
assets or financial liabilities not subsequently measured at FVTPL, transaction costs that are
directly attributable to the acquisition or issue of the financial asset or the financial liability.
Trade receivables that do not contain a significant financing component (determined in
accordance with Ind AS 115 Revenue from Contracts with Customers) are initially measured
at their transaction price and not at fair value.

If the fair value of a financial asset or a financial liability at initial recognition differs from
the transaction price and part of the consideration is not for something other than the
financial instrument (e.g. for goods or services or capital contribution or deemed
distribution) and if the fair value is evidenced by a quoted price in an active market for an
identical asset or liability or based on a valuation technique that uses only data from
observable markets, then, the difference is recognised as a gain or loss on initial recognition
(‘day 1 profit or loss’). In all other cases, the ‘day 1 profit or loss’ is included in the carrying
amount of the asset or liability and, after initial recognition, is recognised as gain or loss
only to the extent that it arises from a change in a factor (including time) that market
participants would take into account when pricing the asset or liability.

2. Transaction costs

Transaction costs are defined as incremental costs that are directly attributable to the
acquisition, issue or disposal of a financial asset or a financial liability. An incremental cost is
one that would not have been incurred if the entity had not acquired, issued or disposed of
the financial instrument.

Transaction costs include fees and commissions paid to agents (including employees acting
as selling agents), advisers, brokers and dealers, levies by regulatory agencies and security
exchanges, and transfer taxes and duties. However, debt premiums or discounts, financing
costs, internal administrative costs and holding costs are not trans- action costs. In practice,
the interpretation of this definition may require significant judgement.

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The consequences of the treatment of transaction costs on initial measurement are:

 For debt instruments subsequently measured at amortised cost or FVTOCI, transaction
costs are included in the calculation of effective interest rate (EIR) - in effect, they are
amortised through profit or loss over the term of the instrument.
 For investments in equity instruments designated as at FVTOCI, the transaction costs
remain in equity and are not subsequently reclassified to profit or loss. An entity may
choose to reclassify within equity the cumulative gain or loss (which includes
transaction costs), for example, when the investment in equity instrument is
derecognised.
 For financial instruments classified as at FVTPL, transaction costs are recognised in
profit or loss immediately on initial recognition.

Financial Assets – Classification and Subsequent Measurement

Under Ind AS 109, financial assets are classified according to the measurement basis. Subsequent
to initial recognition, the financial assets are measured at:

Under Ind AS 109, financial assets are classified according to the measurement basis. Subsequent to
initial recognition, the financial assets are measured at:.

Fair value
through other
comprehensive
income
(FVTOCI)

Fair value through Profit

or Loss (FVTPL)

Investment in equity instruments are required to be measured at FVTPL, except that investment in
equity instruments meeting certain criteria may be irrevocably designated as at FVTOCI on initial
recognition.

Except for financial assets that are designated at initial recognition as at FVTPL, the classification of
a financial asset is based on:
 the entity’s business model for managing the financial assets; and
 the contractual cash flows characteristics of the financial asset.

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1. Business model assessment

 Business model to hold assets to collect contractual cash flows

Financial assets that are held within a business model whose objective is to hold assets
in order to collect contractual cash flows are managed to realise cash flows by collecting
contractual payments over the life of the instrument. That is, the entity manages the
assets held within the portfolio to collect those particular contractual cash flows (instead
of managing the overall return on the portfolio by both holding and selling assets).

In determining whether cash flows are going to be realised by collecting the financial
assets’ contractual cash flows, it is necessary to consider the frequency, value and timing
of sales in prior periods, the reasons for those sales and expectations about future sales
activity. However sales in themselves do not determine the business model and
therefore cannot be considered in isolation. Instead, information about past sales and
expectations about future sales provide evidence related to how the entity’s stated
objective for managing the financial assets is achieved and, specifically, how cash flows

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are realised. An entity must consider information about past sales within the context of
the reasons for those sales and the conditions that existed at that time as compared to
current conditions.

Although the objective of an entity’s business model may be to hold financial assets in
order to collect contractual cash flows, the entity need not hold all of those instruments
until maturity. Thus an entity’s business model can be to hold financial assets to collect
contractual cash flows even when sales of financial assets occur or are expected to occur
in the future.

The business model may be to hold assets to collect contractual cash flows even if the
entity sells financial assets when there is an increase in the assets’ credit risk.

Sales that occur for other reasons, such as sales made to manage credit concentration
risk (without an increase in the assets’ credit risk), may also be consistent with a
business model whose objective is to hold financial assets in order
to collect contractual cash flows.

If more than an infrequent number of such sales are made out of a portfolio and those
sales are more than insig- nificant in value (either individually or in aggregate), the entity
needs to assess whether and how such sales are consistent with an objective of
collecting contractual cash flows. Whether a third party imposes the requirement to sell
the financial assets, or that activity is at the entity’s discretion, is not relevant to this
assessment. An increase in the frequency or value of sales in a particular period is not
necessarily inconsistent with an objective to hold financial assets in order to collect
contractual cash flows, if an entity can explain the reasons for those sales and
demonstrate why those sales do not reflect a change in the entity’s business model. In
addition, sales may be consistent with
the objective of holding financial assets in order to collect contractual cash flows if the
sales are made close to the maturity of the financial assets and the proceeds from the
sales approximate the collection of the remaining contrac- tual cash flows.

 Business model to hold assets both to collect contractual cash flows and to sell
There are various objectives that may be consistent with this type of business model. For
example, the objective of the business model may be to manage everyday liquidity
needs, to maintain a particular interest yield profile or to match the duration of the
financial assets to the duration of the liabilities that those assets are funding. To achieve
such an objective, the entity will both collect contractual cash flows and sell financial
assets.
Compared to a business model whose objective is to hold financial assets to collect
contractual cash flows, this business model will typically involve greater frequency and
value of sales. This is because selling financial assets
is integral to achieving the business model's objective instead of being only incidental to
it. However, there is no threshold for the frequency or value of sales that must occur in
this business model because both collecting contrac- tual cash flows and selling financial
assets are integral to achieving its objective.
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2. Contractual cash flows characteristics test

For a financial asset that is a debt instrument to be measured at amortised cost or FVTOCI,
its contractual terms must give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount outstanding. For the purposes of
applying this requirement, principal is the fair value of the financial asset at initial
recognition, however that principal amount may change over the life of the financial asset
(for example, if there are repayments of principal). Interest consists of consideration for the
time value of money, for the credit risk associated with the principal amount outstanding
during a particular period of time and for other basic lending risks and costs, as well as a
profit margin.

The assessment as to whether contractual cash flows are solely payments of principal and
interest is made in the currency in which the financial asset is denominated.

In practice only debt instruments held are capable of meeting the contractual cash flows
characteristics test discussed above. Derivative assets and investments in equity
instruments will not meet the criteria.

Contractual cash flows that are solely payments of principal and interest on the principal
amount outstanding are consistent with a basic lending arrangement. In a basic lending
arrangement, consideration for the time value of money and credit risk are typically the
most significant elements of interest. However, in such an arrangement, interest can also
include consideration for other basic lending risks (for example, liquidity risk) and costs (for
example, administrative costs) associated with holding the financial asset for a particular
period of time. In addition, interest can include a profit margin that is consistent with a
basic lending arrangement. However, contractual terms that introduce exposure to risks or
volatility in the contractual cash flows that is unrelated to a basic lending arrangement, such
as exposure to changes in equity prices or commodity prices, do not give rise to contractual
cash flows that are solely payments of principal and interest on the principal amount
outstanding. An originated or a purchased financial asset can be a basic lending
arrangement irrespective of whether it is a loan in its legal form.

 Consideration for the time value of money

Time value of money is the element of interest that provides consideration for only the
passage of time. That is, the time value of money element does not provide
consideration for other risks or costs associated with holding the financial asset. In order
to assess whether the element provides consideration for only the passage of time, an
entity applies judgement and considers relevant factors such as the currency in which
the financial asset is denominated and the period for which the interest rate is set.

 Fixed cash flows

A non-prepayable fixed rate instrument that has a fixed return provides the holder with
consideration for the time value of money.

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Example: Zero coupon bond

Entity W acquires a zero coupon bond that was originally issued by Entity X. The terms of
the bond require repayment of `10 million by Entity X in 3 years and is not prepayable.
The terms of the bond do not include a contractual interest rate.

Whether Entity W acquired the zero coupon bond at the date it was originally issued by
Entity X or at a later date does not affect the assessment as to whether the asset can be
classified at amortised cost or FVTOCI by Entity W. At the date of acquisition, Entity W
has a financial asset that provides a fixed return of interest and repayment of principal.
The fixed return is the difference between the amount paid to acquire the bond and the
amount due from Entity X at redemption.

 Floating rate loans

A financial asset that has a variable rate of interest that consists of consideration for the
time value of money, the credit risk associated with the principal amount outstanding
during a particular period of time (the consideration for credit risk may be determined at
initial recognition only, and so may be fixed) and other basic lending risks and costs, as
well as a profit margin, will meet the contractual cash flow characteristics test.

 Prepayment options
A contract may permit the issuer to prepay, or the holder to put back, a debt instrument
before maturity. Whether a prepayment option passes the contractual cash flows
characteristics test will depend on what events are needed to occur that then permit the
issuer to prepay or the holder to put back, and how much is the prepayment amount.
Generally, both factors are important in determining whether the financial asset gives
rise only to contractual cash flows that are a return of principal and interest on the
principal outstanding.

When the amount and/or timing of contractual cash flows are contingent on a future
event, consideration must be given to the nature of the event. While the nature of the
contingent event in itself is not a determinative factor in assessing whether the
contractual cash flows are solely payments of principal and interest, it may be an
indicator.

Therefore, a prepayment option that is exercisable only when an event happens that is
unrelated to the risks asso- ciated with a basic lending arrangement, for example, a
return not based on the time value of money, credit risk of the borrower and liquidity
risk of the instrument, may not pass the contractual cash flows characteristics test. The
inclusion of risks unrelated to a basic lending arrangement may not provide a return of
principal and interest on the principal outstanding.

 Perpetual debt instruments

The fact that an instrument is perpetual (i.e. it has no stated maturity date) does not in
itself mean that the contrac- tual cash flows are not payments of principal and interest

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on the principal amount outstanding. Consideration will need to be given to the

contractual interest rate, which will include whether it provides for consideration for the
time value of money, credit risk of the borrower, liquidity risk, and a profit margin for
the lender. Variability in the contrac- tual cash flows due to factors other than this will
generally result in the instrument failing the contractual cash flows characteristics test.

A perpetual instrument is like a stream of continuous (multiple) extension options. Such

options will result in contrac- tual cash flows that are payments of principal and interest
on the principal amount outstanding if the contractual cash flows following each interest
payment (i.e. each extension option) are themselves considered solely payments of
principal and interest on the principal amount outstanding.

A perpetual interest may also be prepayable by the issuer, or the holder may demand
early repayment. The prepay- ment feature shall be considered in the same way as a
prepayment feature on redeemable debt, i.e. one that is not perpetual and has a
specified term.

3. Criteria for amortised cost measurement

Two conditions need to be satisfied to measure a financial asset at amortised cost:

 The assets must be held in a business model whose objective is to collect the
contractual cash flows (as opposed to an objective of realising fair value through
sale) (the business model test); and
 The contractual cash flows are solely payments of principal and interest on principal,
where interest is the compen- sation for the time value of money and credit risk (the
contractual cash flows characteristics test).

Because both the above conditions (the business model test and the contractual cash flow
characteristics test) must be met for amortised cost measurement, the order in which the
tests are performed is irrelevant. However, in practice, it is likely that the business model
test will be considered first, because it is performed at a higher level of aggregation and not
for each financial asset individually.

4. Criteria for measurement at FVTOCI

A financial asset should be measured at FVTOCI if both of the following conditions are met:
 The asset is held in a business model in which assets are managed both in order to
collect contractual cash flows and for sale (the business model test); and
 The contractual terms of the financial asset give rise on specified dates to cash flows
that are solely payments of principal and interest on the principal amount
outstanding (the contractual cash flows characteristics test).

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For a typical debt instrument, the classification would be as under:

Test Debt Instrument

Business Model 1. Hold to 2. Hold to collect Either 1 Neither 1 Neither 1
collect sales
Test ? and or 2 nor 2 nor 2
Cash Flow test ? Met Met Not Met Not Met Met
Classification Amortised FVTOCI* FVTPL FVTPL FVTPL
*except if FVTPL designation
cost* is elected

 Designation of equity instruments as at FVTOCI

At initial recognition, an entity may make an irrevocable election to present in other

comprehensive income subse- quent changes in fair value of an investment in equity
instrument that is not held for trading nor contingent consid- eration recognised by an
acquirer in a business combination to which Ind AS 103 Business Combinations applies.
This election is made on an instrument-by-instrument (i.e. share-by-share) basis.

5. Criteria for measurement at FVTPL

Any financial asset that does not qualify for amortised cost measurement or measurement
at FVTOCI must be measured subsequent to initial recognition at FVTPL (except in the case
of an investment in an equity instrument irrevocably designated as at FVTOCI). In addition,
financial assets that are held for trading or designated at initial recognition as at FVTPL must
be measured subsequent to initial recognition at FVTPL.

 Financial assets held for trading

A financial asset is held for trading if:

 it is acquired principally for the purpose of selling it in the near term;
 on initial recognition it is part of a portfolio of identified financial instruments
that are managed together and for which there is evidence of a recent actual
pattern of short-term profit-taking; or
 is a derivative (except for a derivative that is a financial guarantee contract or a
designated and effective hedging instrument).

 Designation of certain financial assets as at FVTPL

An entity may, at initial recognition, irrevocably designate a financial asset that meets
the conditions for amortised cost measurement or measurement at FVTOCI as at FVTPL
if that designation eliminates or significantly reduces a measurement or recognition
inconsistency (sometimes referred to as an ‘accounting mismatch’) that would have
occurred if the financial asset had been measured at amortised cost or FVTOCI
respectively.

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Investment in equity instruments are required to be measured at FVTPL, except that

investment in equity instruments meeting certain criteria may be irrevocably designated
as at FVTOCI on initial recognition.

6. Subsequent measurement

The classification of financial instruments determines how they are subsequently measured.

 Amortised cost

The amortised cost category applies only to debt instrument financial assets that meet
the specified criteria (see section 8.3 above). Amortised cost measurement requires the
application of the effective interest method.

Amortised cost of a financial instrument is defined as the amount at which the financial
asset or financial liability is measured at initial recognition minus the principal
repayments, plus or minus the cumulative amortisation using the effective interest
method of any difference between that initial amount and the maturity amount and, for
financial assets, adjusted for any loss allowance.

Gains and losses resulting from fluctuations in fair value are not recognised for financial
assets classified in the amortised cost measurement category.

 FVTOCI

Two types of financial assets are measured at FVTOCI:

 Investments in particular equity instruments that may irrevocably be designated
at initial recognition as at FVTOCI (see section 8.4.1 above). If this election is
made, only dividend income that does not clearly represent a recovery of part of
the cost of the investment is recognised in profit or loss, with all other gains and
losses (including those relating to foreign exchange) recognised in OCI. Those
gains and losses remain permanently in equity and are not subsequently
transferred to profit or loss even on derecognition. However, the entity may
transfer the cumulative gain or loss within equity.
 Debt instruments measured at FVTOCI: For these, changes in fair value should be
recognised in OCI except for:
- interest calculated using the effective interest rate;
- foreign exchange gains and losses; and
- impairment gains and losses,
until the financial asset is derecognised or reclassified.

When the financial asset is derecognised, the cumulative gain or loss previously
recognised in OCI is reclassified from equity to profit or loss as a reclassification
adjustment under Ind AS 1 Presentation of Financial Statements.

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If a debt instrument asset is measured at FVTOCI, the amounts that are recognised in
profit or loss are the same as the amounts that would have been recognised in profit or
loss if the financial asset had been measured at amortised cost.

 FVTPL
Assets classified as at FVTPL are measured at fair value. Gains and losses that arise as a
result of changes in fair value are recognised in profit or loss, except for those arising on
hedging instruments that are designated in effective cash flow hedges or hedges of net
investments in foreign operations.
Gains and losses that arise between the end of the last reporting period and the date an
instrument is derecognised do not constitute a separate ‘profit/loss on disposal’. Such
gains and losses will have arisen prior to the disposal, while the item is still being
measured at FVTPL, and should be recognised in profit or loss when they occur.
 Hedged items
Ind AS 109 includes specific requirements to be applied when accounting for a financial
asset that is a hedged item.
 Measurement of unquoted equity instruments
Ind AS 109 requires all investments in equity instruments and contracts on those
instruments to be measured at fair value. However, Ind AS 109 also requires that in
some limited circumstances, cost may be an appropriate estimate of fair value. That may
be the case if insufficient more recent information is available to measure fair value, or
if there
is a wide range of possible fair value measurements and cost represents the best
estimate of fair value within that range. Cost is never the best estimate of fair value for
investments in quoted equity instruments (or contracts on quoted equity instruments).

Indicators that cost might not be representative of fair value include:

 a significant change in the performance of the investee compared with budgets,
plans or milestones;
 changes in expectation that the investee’s technical product milestones will be
achieved;
 a significant change in the market for the investee’s equity or its products or
potential products;
 a significant change in the global economy or the economic environment in which
the investee operates;
 a significant change in the performance of comparable entities, or in the
valuations implied by the overall market;
 internal matters of the investee such as fraud, commercial disputes, litigation,
changes in management or strategy;
or

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 evidence from external transactions in the investee’s equity, either by the

investee (such as a fresh issue of equity), or by transfers of equity instruments
between third parties.
This list is not exhaustive. An entity is required to use all information about the
performance and operations of the investee that becomes available after the date of
initial recognition. To the extent that any relevant factors indicate that cost may not be
representative of fair value, the entity is required to measure fair value.

For particular entities such as financial institutions and investment funds the cost of
equity investments cannot be considered representative of fair value.

7. Reclassification of financial assets

An entity is required to reclassify financial assets when it changes its business model for
managing financial assets. Investments in equity instruments that are designated as at
FVTOCI at initial recognition cannot be reclassified, since, the election to designate as at
FVTOCI is irrevocable.
It is not appropriate for financial assets that are designated as at FVTPL to be reclassified
after initial recognition. Reclassifications are expected to be very infrequent. Such changes
must be determined by the entity’s senior manage-ment as a result of external or internal
changes and must be significant to the entity’s operations and demonstrable to external
parties. Accordingly, a change in an entity’s business model will occur only when an entity
either begins or ceases to perform an activity that is significant to its operations; for
example, when the entity has acquired, disposed of or terminated a business line.

The following are not changes in business model:

 a change in intention related to particular financial assets (even in circumstances of
significant changes in market conditions);
 the temporary disappearance of a particular market for financial assets; and
 a transfer of financial assets between parts of the entity with different business
models.

If there has been no change in the business model for managing financial assets, if the
terms of the financial assets remain unchanged, or the terms of a financial asset change but
the asset is not derecognised, reclassification is not permitted. If the terms of an instrument
change sufficiently to warrant derecognition, this would not be a reclassi- fication; instead,
the old asset is derecognised and the new one is recognised. In cases where terms inherent
in the instrument expire or take effect during the instrument’s life, and the asset continues
to be recognised, the changing terms would not change the classification assessment made
at initial recognition.

If an entity reclassifies financial assets, it is required to apply the reclassification

prospectively from the reclassifica- tion date defined as the first day of the first reporting
period following the change in business model that results in the entity reclassifying
financial assets. The reclassification applies prospectively from the reclassification date and
therefore previously recognised gains, losses (including impairment gains or losses) or
interest are not restated.

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Ind AS 109 is not explicit as to how to interpret the “first day of the first reporting period
following the change in business model” in the context of interim financial statements.
Specifically, it is not clear whether the “first reporting period following the change in
business model” is the next interim financial reporting period or the next annual financial
reporting period.

On balance, it is appropriate to regard an interim period as a “reporting period” for this

purpose. Therefore, when the next financial reporting period is an interim financial period,
the start of that period will be the reclassification date. This is supported by paragraph
15B(l) of Ind AS 34 Interim Financial Reporting which requires disclosure in interim financial
reports of “changes in the classification of financial assets as a result of a change in the
purpose or use of those assets”, if those change are significant.

Example: Date of reclassification for interim financial statements

Entity A changes its business model on 15 August 20X0 and, as a result, must reclassify all
affected financial assets at the reclassification date (being the first day of the entity’s next
reporting period) from amortised cost to FVTPL.

Entity A has the following period-ends:

 half-year interim period end: 30 September 20X0;
 third-quarter interim period end: 31 December 20X0; and
 annual period end: 31 March 20X1.

The reclassification date should be 1 October 20X0, being the first day of the entity’s next
reporting period following the change in business model. Therefore, the third-quarter
interim financial statements will reflect the effect of the reclassification of financial assets at
1 October 20X0. Further, it would not be appropriate to have multiple reclassification dates
for a change in one business model. Therefore, the reclassification date of 1 October 20X0
also applies in the annual financial statements ending 31 March 20X1.

Financial statements Measurement basis of financial assets

subject to reclassification
Half-year interim financial statements ending Amortised cost
30 September 20X0
Third-quarter interim financial state- ments FVTPL
ending 31 December 20X0
Annual financial statements ending 31 March Six months at amortised cost and six
20X1 months at FVTPL

 Measurement on reclassification of financial assets

Ind AS 109 contains detailed requirements as to how to measure a financial asset when
it is reclassified from one classification category to another. Below is a summary of the
measurement requirements that apply at the reclassification date:

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When a financial asset is reclassified from amortised cost to FVTOCI (or vice versa), the
measurement of expected credit losses will not change as both classification categories
apply the same impairment approach. However, the presentation and disclosure of the
impairment allowance will differ.

Ind AS 1 requires certain specified disclosures when a financial asset is reclassified from
amortised cost to FVTPL or is reclassified from FVTOCI to FVTPL.

Financial Liabilities - Classification and Subsequent Measurement

All financial liabilities are required to be classified and subsequently measured at amortised cost,
except for:
 financial liabilities at FVTPL;
 financial liabilities that arise when a transfer of a financial asset does not qualify for
derecognition or when the continuing involvement approach applies;
 financial guarantee contracts not designated as at FVTPL that are not accounted for under
Ind AS 4 Insurance
 Contracts; and
 commitments to provide a loan at a below-market interest rate.
Financial liabilities that are designated as hedged items are subject to the hedge accounting
requirements.
1. Financial liabilities at FVTPL
This category of financial liabilities can further be divided into the following two sub-
categories:
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 financial liabilities classified as held for trading; and

 financial liabilities designated by the entity as FVTPL. This is an option available in
limited circumstances. The desig- nation is irrevocable so that, once it has been
made, the liability cannot subsequently be reclassified into another category during
its life.
 Financial liabilities classified as held for trading
A financial liability is held for trading if it falls into one of the following categories:
 financial liabilities incurred principally for the purpose of repurchasing them in
the near term;
 financial liabilities that on initial recognition form part of a portfolio of identified
financial instruments that are managed together and for which there is evidence
of a recent actual pattern of short-term profit-taking; and
 derivative liabilities, unless the derivative is a financial guarantee contract or it
forms part of a designated and effective hedging relationship.
The following are examples of liabilities that would be classified as held for trading and
thus included in held for trading category:
 an interest rate swap that has negative fair value that is not accounted for as a
hedging instrument;
 a derivative liability incurred upon writing a foreign exchange option that is not
accounted for as a hedging instrument;
 an obligation to deliver financial assets borrowed by a short-seller (i.e. an entity
that sells financial assets it has borrowed and does not yet own); and
 a quoted debt instrument that the issuer plans to buy back in the near term
depending on movements in the debt instrument’s fair value, i.e. a financial
liability that is incurred with the intention to repurchase it in the near term.
 Designation of financial liabilities as at FVTPL
A financial liability may upon initial recognition be designated as at FVTPL only in one of
the following circumstances:
 it eliminates or significantly reduces a measurement or recognition inconsistency
(sometimes referred to as ‘an accounting mismatch’) that would otherwise arise
from measuring assets or liabilities or recognising the gains and losses on them on
different bases;

Example: Fair value option: issued fixed rate debt

Entity A issues fixed rate debt. In order to economically hedge the fair value risk
associated with interest payments on the fixed rate debt, Entity A concurrently enters
into an interest rate swap with a bank (receive fixed, pay floating), which has the same
terms and payment dates as the debt. The interest rate swap is a derivative that must
be measured at FVTPL. Entity A does not wish to apply fair value hedge accounting
because it does not wish to prepare any hedge documentation and it does not have the
processes in place to monitor hedge effectiveness. By designating the fixed rate debt as
at FVTPL on initial recognition, the entity will achieve a substantial offset in profit or
loss against the fair value movements on the held for trading derivative. Because the
instruments share a common risk (interest rate risk), Entity A will seek to demonstrate
that applying the fair value option results in more relevant information because it
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significantly reduces a measurement inconsistency that would otherwise arise from

measuring the derivative at FVTPL and measuring the debt at amortised cost.
Example: Fair value option: lack of accounting mismatch
Entity A borrows (through a single instrument) `1,000,000 from a third-party bank and,
at the same time, uses some of the borrowing to acquire 10 similar financial assets each
of a value of `50,000 which are all classified as at FVTPL. Entity A wants to reduce the
measurement inconsistency by designating the liability as at FVTPL. However, if all of
the borrowing were accounted for at FVTPL, Entity A would create an accounting
mismatch in profit or loss related to the portion of the borrowing (`500,000) not
matched by the financial assets measured at FVTPL. This accounting mismatch is
comparable to the mismatch that would arise by not applying the fair value option in
the first place. Therefore, Entity A cannot apply the fair value option to its financial
liabilities because it would not significantly reduce the accounting mismatch between
the assets and the liability.

 a group of financial liabilities or financial assets and financial liabilities is managed

and its performance is evaluated on a fair value basis, in accordance with a
documented risk management or investment strategy, and information about
the group is provided internally on that basis to the entity’s key management
personnel (as defined in Ind AS 24 Related Party Disclosures).
 in the case of a hybrid financial liability containing one or more embedded
derivatives, an entity may designate the entire hybrid (combined) contract as at
FVTPL unless:
- the embedded derivative does not significantly modify the cash flows that
otherwise would be required by the contract; or
- it is clear with little or no analysis when a similar hybrid instrument is first
considered that separation of the embedded derivative is prohibited (e.g. a
prepayment option embedded in a loan that permits the holder to prepay the
loan for approximately its amortised cost).

Example: Fair value option: commodity-linked debt

Entity Q issues a debt instrument that has interest payments linked to a basket of
commodity prices. The linking to commodity prices is considered to be a non-closely
related embedded derivative that would require separa- tion and measurement at
FVTPL. Entity Q may choose at initial recognition to designate the whole debt instru-
ment as at FVTPL to avoid separating out the embedded derivative.

The election to designate a financial liability as at FVTPL has to be made at initial

recognition of the financial liability and cannot subsequently be revoked. This is the
case, even if the instrument giving rise to the mismatch is derecognised.
2. Classification of financial liabilities assumed in a business combination
When financial liabilities are assumed in a business combination, those liabilities should be
classified in the consol- idated financial statements of the acquirer into one of the
permitted categories mentioned above. It is entirely possible that the classification of a
financial liability for these purposes may differ from its classification in the financial
statements of the acquiree. For example, the acquirer in its consolidated financial
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statements may choose to designate a financial liability as at FVTPL at initial recognition

even though the acquiree may have classified it otherwise when it first recognised the
liability. These differences can arise because ‘initial recognition’ from the acquirer’s
perspective is the date of acquisition of the subsidiary and its classification decisions are
made at that date.
Ind AS 103 provides clear evidence stating that, at the acquisition date, the acquirer should
make any classifications, designations concerning financial assets or financial liabilities
assumed in a business combination in accordance with pertinent conditions at that date.
3. Subsequent measurement
Amortised cost of financial liabilities is determined using the effective interest method.
In case of financial liabilities measured at FVTPL, fair value gains and losses are recognised
in profit or loss except that in the case of financial liabilities (other than loan commitments
or financial guarantee contracts) that are designated at FVTPL, the gains or losses are
required to be presented as follows:
 the amount of the change in the fair value of the financial liability that is attributable
to changes in the credit risk of that liability should be presented in OCI; and
 the remainder of the change in the fair value of the liability should be presented in
profit or loss unless the treatment of the effects of changes in the liability’s credit
risk described above would create or enlarge an accounting mismatch in profit or loss
(in which case all gains or losses are recognised in profit or loss).
In making the determination of whether recognising changes in the liability’s credit risk in
OCI will create or enlarge an accounting mismatch in profit or loss, an entity must assess
whether it expects that the effects of changes in the liability’s credit risk will be offset in
profit or loss by a change in the fair value of another financial instrument measured at
FVTPL. Such an expectation must be based on an economic relationship between the
characteristics of the liability and the characteristics of the other financial instrument. That
determination is made at initial recognition and is not reassessed.
All gains and losses on loan commitments and financial guarantee contracts that are
designated as at FVTPL are recognised in profit or loss.
4. Hedged items
Ind AS 109 includes specific requirements to be applied when accounting for a financial
liability that is a hedged item.
5. Reclassification of financial liabilities
Reclassifications of financial liabilities into and out of the FVTPL category are prohibited.
The following changes in circumstances are not reclassifications:
 a derivative that was previously a designated and effective hedging instrument in a
cash flow hedge or net invest- ment hedge no longer qualifies as such; and
 a derivative becomes a designated and effective hedging instrument in a cash flow
hedge or net investment hedge.

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Impact of Ind AS 32 and Ind AS 109

1. Classification
Currently under Indian GAAP, equity and preference shares are classified on the basis of their
legal form and dividends payable on these instruments are recognised as an appropriation from
earnings. Convertible debt is classi- fied as a debt instrument. As per the requirements of Ind AS
32, capital instruments will have to be classified on the basis of the issuer’s contractual
obligation to deliver cash or other financial assets. Dividend on capital instruments classified as
a financial liability is recognised as an interest expense. Convertible debt instruments are split
between liability and equity components and accordingly classified in the financial statements.
This reclassification between capital and debt and the consequential change in the
classification of dividends paid on these as interest expense will impact financial ratios, e.g.
capital gearing ratios, interest coverage ratios. These could have an impact on certain debt
covenants and the same should be ascertained and addressed.

2. Recognition and measurement

Currently under Indian GAAP, all investments are categorised as long-term investments or
current investments. A current investment is an investment that is by its nature readily
realisable and is intended to be held for not more than one year from the date on which such
investment is made. Current investments are carried at the lower of cost and fair value. Long-
term investments carried at cost less provision for diminution in value other than temporary.

The scenario completely changes under Ind AS 109 and financial assets including equity
investments will have to be measured at fair value. At initial recognition, an entity may make an
irrevocable election to present in OCI subsequent changes in fair value of an investment in
equity instrument that is not held for trading in which case the changes in fair value are
recognised in OCI. If such an election is not made, there will be a high degree of volatility in the
income statement.

Entities will now need to assess their business models for holding financial assets. For some
entities, such as non-fi- nancial corporations, the assessment may be relatively simple since
their financial assets may be limited to trade receivables and bank deposits for which the
amortised cost criteria are likely to be met. For entities that engage in a broader range of
activities involving financial assets (e.g., lenders, investors in debt securities held for treasury
activ- ities and traders), complexities in the business model may require increased management
judgement in ascertaining whether assets are held to collect contractual cash flows and/or for
sale. Since part of the business model assessment is also dependent on the history of how
entities have achieved the objective in the business model (for example, whether there has
been significant recurring sales and reasons for such sales), entities should start tracking this
infor- mation as soon as possible in order to have sufficient history to make the comparison.

Computation of fair values for unquoted investments may also pose an issue considering that
there may not be enough independent valuers to determine these values.

Modification to the current IT systems may be necessary considering the shift to fair value
accounting. A lot of infor- mation not readily traceable from accounting entries may have to be
captured. The impact would be significant for the treasury function of corporates.

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FAST PRACTICAL QUESTION WITH SOLUTION

Q1. (Exchange of Financial Liability at Unfavourable terms)

A company borrowed ` 50 lacs @ 12% p.a. Tenure of the loan is 10 years. Interest is payable
every year and the principal is repayable at the end of 10th year. The company defaulted in
payment of interest for the year 4, 5 and 6.

A loan reschedule agreement took place at the end of 7 year. As per the agreement the
company is required to pay ` 90 lacs at the end of 8th year. Calculate the additional amount
to be paid on account of rescheduling and also the book value of loan at the end of 8th year
when reschedule agreement took place.

Solution

Assumption: Interest is compounded in case of default.

Outstanding Amount at the end of 8th year = ` 50,00,000 x 1.12 x 1.12 x 1.12 x 1.12 x 1.12

= ` 88,11,708 (i.e. adding interest for 4th to 8th year) Rescheduled amount to be paid at the
end of the 8th year = ` 90,00,000
Additional amount to be paid on rescheduling = ` 90,00,000 - ` 88,11,7081 = ` 1,88,291

Q2. Entity A holds an option to purchase equity shares in a listed entity B for ` 100 per share at
the end of a 90 day period. Evaluate the contract whether a financial asset or a financial
liability? What if the entity A has written the option?

Solution

The above call option gives entity A, a contractual right to exchange cash of ` 100 for an
equity share in another entity and will be exercised if the market value of the share exceeds
`100 at the end of the 90 day period. If the market value of a share will be such that the
entity A will gain on the exercise date, it will exercise the call option.

Since entity A stands to gain if the call option is exercised, the exchange is potentially
favourable to the entity. Therefore, the option is a derivative financial asset from the time the
entity becomes a party to the option contract.

On the other hand, if entity A writes an option under which the counterparty can force the
entity to sell equity shares in the listed entity B for ` 100 per share at any time in the next 90
days, then entity A will be said to have a contractual obligation to exchange its equity shares
to another entity for cash of ` 100 per share on potentially unfavourable terms i.e. if the
holder exercises the option, on account of the market price per share being above the
exercise price of ` 100 per share at the end of the 90 day period.

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Since entity A stands to lose if the option is exercised, the exchange is potentially
unfavourable and the option is a derivative financial liability from the time the entity
becomes a party to the option contract.

Q3. (Mandatorily Redeemable Preference Shares With Mandatory Fixed Dividends)

A Company has issued 6% mandatorily redeemable preference shares with mandatory fixed
dividends. Evaluate whether such preference shares are an equity instrument or a financial
liability to the issuer entity? [PM]

Solution

In determining whether a mandatorily redeemable preference share is a financial liability or

an equity instrument, it is necessary to examine the particular contractual rights attaching to
the instrument's principal and return components.

The instrument in this example provides for mandatory periodic fixed dividend payments and
mandatory redemption by the issuer for a fixed amount at a fixed future date. Since there is a
contractual obligation to deliver cash (for both dividends and repayment of principal) to the
shareholder that cannot be avoided, the instrument is a financial liability in its entirety.

Q4. (Non-redeemable Preference Shares With Mandatory Fixed Dividends)

A Company issued non-redeemable preference shares with mandatory fixed dividends.

Evaluate whether such preference shares are an equity instrument or a financial liability to
the issuer entity?

Solution

When preference shares are non-redeemable, the appropriate classification is determined by

the other rights attached to them. Classification is based on an assessment of the contractual
arrangement's substance and the definitions of a financial liability and an equity instrument.

It is necessary to examine the particular contractual rights attaching to the

instrument's principal and return components. In this example, the shares are non-
redeemable and thus the amount of the principal has equity characteristics, but the
entity has a contractual obligation to pay dividends that provides the shareholders with
a lender's return. This obligation is not negated if the entity is unable to pay the dividends
because of lack of funds or insufficient distributable profits. Therefore, the obligation to pay
the dividends meets the definition of a financial liability.

The overall classification is that the shares may be a compound instrument, which may
require each component to be accounted for separately. It would be a compound instrument
if the coupon was initially set at a rate other than the prevailing market rate or the terms
specified payment of discretionary dividends in addition to the fixed coupon. If the coupon on
the preference shares was set at market rates at the date of issue and there were no

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provisions for the payment of discretionary dividends, the entire instrument would be
classified as a financial liability, because the stream of cash flows is in perpetuity.

Q5. (Non-redeemable Preference Shares with Dividend Payments linked to Ordinary Shares)

A company issued Non-redeemable preference shares with dividend payments linked to

ordinary shares. Evaluate whether such preference shares are an equity instrument or a
financial liability to the issuer entity?

Solution

An entity issues a non-redeemable preference shares on which dividends are payable only if
the entity also pays a dividend on its ordinary shares.

The dividend payments on the preference shares are discretionary and not contractual,
because no dividends can be paid if no dividends are paid on the ordinary shares, which are
an equity instrument. As the perpetual preference shares contain no contractual obligation
ever to pay dividends and there is no obligation to repay the principal, they should be
classified as equity in their entirety.

Where the dividend payments are also cumulative, that is, if no dividends are paid on the
ordinary shares, the preference dividends are deferred, the perpetual shares will be classified
as equity only if the dividends can be deferred indefinitely and the entity does not have any
contractual obligations whatsoever to pay those dividends.
A liability for the dividend payable would be recognised once the dividend is declared.

Q6. Let us say on 30th March 2015 an entity enters into an agreement to purchase a Financial
Asset for ` 100 which is the Fair Value on that date.
On Balance Sheet date i.e. 31/3/2015 the Fair Value is 102 and on Settlement date
i.e. 2/4/2015 Fair Value is 103.
Pass necessary Journal entries on trade date and settlement date when the asset acquired is
measured at
(a) Amortised cost
(b) FVTPL
(c) FVTOCI [PM]

Solution
Financial Asset at Amortised Cost – Trade Date Accounting
Dates Journal Entry Amount Amount
30/3/2015 Financial Asset Dr. 100
To Payables 100
31/3/2015 No Entry
2/4/2015 Payables Dr. 100
To Cash 100

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Financial Asset at Amortised Cost – Settlement Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 No Entry
31/3/2015 No Entry
Financial Asset Dr. 100
2/4/2015
To Cash 100

Financial Asset at FVTPL – Trade Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 Financial Asset Dr. 100
To Payables 100
31/3/2015 Financial Asset Dr. 2
To P&L 2
2/4/2015 Financial Asset Dr. 1
1
To P&L
Payables Dr. 100
To Cash 100

Financial Asset at FVTPL– Settlement Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 No Entry
31/3/2015 Fair Value Change Dr. 2
To P&L 2
2/4/2015 Fair Value Change Dr. 1
To P&L 1
Financial Asset Dr. 103
To Cash 100

To Fair Value Change 3

Financial Asset at FVTOCI – Trade Date Accounting

Dates Journal Entry Amount Amount
30/3/2015 Financial Asset Dr. 100
To Payables 100
31/3/2015 Financial Asset Dr. 2
To OCI 2
2/4/2015 Financial Asset Dr. 1
To OCI 1
Payables Dr. 100
To Cash 100

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Financial Asset at FVTOCI – Settlement Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 No Entry
31/3/2015 Fair Value Change Dr. 2
To OCI 2
2/4/2015 Fair Value Change Dr. 1
1
To OCI
103
Financial Asset
100
Dr.
3
To Cash
To Fair Value Change
Q7. (Financial Asset Accounted as FVTPL)
A Company invested in Equity shares of another entity on 15th March for ` 10,000.
Transaction Cost = ` 200 (not included in `10,000)
Fair Value on Balance Sheet date i.e. 31st March 2015 = ` 12,000. Pass necessary Journal
Entries

Solution

Date Particulars Dr Cr
15/3/2015 Investment A/c 10,000
Transaction Cost A/c 200
To Bank 10,200

31/3/2015 Investment A/c 2,000

To Fair Value Gain A/c 2,000
31/3/2015 P&L A/c 200
To Transaction Cost A/c 200
31/3/2015 Fair Value Gain 2,000
A/c 2,000
To P&L A/c
Q8. (Financial Asset Accounted as FVTOCI)
A Company invested in Equity shares of another entity on 15th March for ` 10,000.
Transaction Cost = ` 200 (not included in ` 10,000). Fair Value on Balance Sheet date i.e. 31st
March 2015 = ` 12,000. Pass necessary Journal entries.

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Solution

Date Particulars Dr Cr
15/3/2015 Investment A/c 10,200
To Bank 10,200
31/3/2015 Investment A/c 1,800
To Fair Value Gain A/c 1,800
31/3/2015 Fair Value Gain A/c 1,800
To OCI A/c 1,800
31/3/2015 OCI A/c 1,800
To Fair Value Reserve A/c 1,800

Q9. (Financial Asset Accounted as Amortised Cost)

A Company lends ` 100 lacs to another company @ 12% p.a. interest on 1/4/2015. It incurs
`40,000 incremental costs for documentation.
Loan tenure = 5 years with Interest charged annually.
Fair Value of Loan = 99,40,000 (100 lacs – 1 lac + 40,000). Pass necessary Journal entries.
[PM]
Solution

This is based on the assumption that interest rate is based on market rate of interest.
Date Particulars Dr Cr
1/4/2015 Loan A/c 100 lacs
To Bank A/c 100 lacs

1/4/2015 Loan Processing Expense A/c 40,000

To Bank A/c 40,000
1/4/2015 Loan A/c 40,000
To Loan Processing Expense A/c 40,000

Subsequent entries would be explained under subsequent measurement basis.

Q10. An entity is about to purchase a portfolio of fixed rate assets that will be financed by fixed
rate debentures. Both financial assets and financial liabilities are subject to the same interest
rate risk that gives rise to opposite changes in fair value that tend to offset each other.
Comment? [PM]

Solution

In the absence of the fair value option, the entity may have classified the fixed rate assets as
FVTOCI with gains and losses on changes in fair value recognised in other comprehensive
income and the fixed rate debentures at amortised cost. Reporting both the assets and the
liabilities at fair value through profit and loss i.e. FVTPL corrects the measurement
inconsistency and produces more relevant information.
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Q11. Sea Ltd. has lent a sum of ` 10 lakhs @ 18% per annum for 10 years. The loan had a Fair Value
of ` 12,23,960 at the effective interest rate of 13%. To mitigate prepayment risks but at the
same time retaining control over the loan, Sea Ltd. transferred its right to receive the
Principal amount of the loan on its maturity with interest, after retaining rights over 10% of
principal and 4% interest that carries Fair Value of ` 29,000 and ` 1,84,620 respectively. The
consideration for the transaction was ` 9,90,000. The interest component retained included a
2% fee towards collection of principal and interest that has a Fair Value of ` 65,160. Defaults,
if any, are deductible to a maximum extent of the company’s claim on Principal portion. You
are required to show the Journal Entries to record derecognition of the Loan. [Nov. 2013]

Solution:
(i) Calculation of securitized component of loan

` `
Fair Value 12,23,960
Less: Principal strip receivable (fair value) 29,000
Less: Interest strip receivable (fair value) 1,19,460
Less: Value of service asset (fair value) 65,160 1,84,620 2,13,620
10,10,340

(ii) Apportionment of carrying amount in the ratio of fair values

Fair value Apportionment

(`) (`)
Securitized component of 10,10,340 × 10,00,000
loan 10,10,340 12,23,960 8,25,468
Principal strip 29,000 × 10,00,000
receivable 29,000 12,23,960 23,694
Interest strip receivable 1,19,460 × 10,00,000
1,19,460 12,23,960 97,601
Servicing asset 65,160 × 10,00,000
65,160 12,23,960 53,237

(iii) Entries to record the derecognition of the Loan

` ` `
Bank A/c Dr. 9,90,000
To Loan A/c
To Profit & Loss A/c 8,25,468
(Being entry for securitization of 90% principal 1,64,532
with 14% interest)
Interest strip A/c Dr. 97,601
Servicing asset A/c Dr. 53,237
Principal strip A/c Dr. 23,694
To Loan A/c 1,74,532
(Being entry for interest, servicing asset and
principal strips received)

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Q12. (Factoring with / without recourse)

Entity A (the transferor) holds a portfolio of receivables with a carrying value of ` 1,000,000.
It enters into a factoring arrangement with entity B (the transferee) under which it transfers
the portfolio to entity B in exchange for ` 900,000 of cash.

Entity B will service the loans after their transfer and debtors will pay amounts due directly to
entity B. Entity A has no obligations whatsoever to repay any sums received from the factor
and has no rights to any additional sums regardless of the timing or the level of collection
from the underlying debts. Comment. [PM]

Solution

Entity A has transferred its rights to receive the cash flows from the asset via an assignment
to entity B. Furthermore, as entity B has no recourse to entity A for either late payment risk
or credit risk, entity A has transferred substantially all the risks and rewards of ownership of
the portfolio.

Hence, entity A derecognises the entire portfolio. The difference between the carrying value
of ` 1,000,000 and cash received of ` 900,000 i.e. ` 100,000 is recognised immediately as a
financing cost in profit or loss.

Had Entity A not transferred its rights to receive the cash flows from the asset or there would
have been any credit default guarantee given by entity A, then it would have not led
to complete transfer of risk and rewards and entity A could not derecognise the portfolio due
to the same.

Q13. Entity XYZ enters into a fixed price forward contract to purchase 10,00,000 kilograms
of copper in accordance with its expected usage requirements.

The contract permits XYZ to take physical delivery of the copper at the end of 12 months or to
pay or receive a net settlement in cash, based on the change in fair value of copper. Is the
contract covered under Financial Instruments standard?

Solution
The above contract needs to be evaluated to determine whether it falls within the scope of
the financial instruments standards.
The contract is a derivative instrument because there is no initial net investment, the contract
is based on the price of copper and it is to be settled at a future date.
However, if XYZ intends to settle the contract by taking delivery and has no history for similar
contracts of settling net in cash, or of taking delivery of the copper and selling it within a
short period after delivery for the purpose of generating a profit from short term fluctuations
in price or dealer's margin, the contract is not accounted for as a derivative under Ind AS 109.
Instead, it is accounted for as an executory contract and if it becomes onerous then Ind AS 37
would apply.
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Q14. On 1 April, 2015, Delta Ltd. issued ` 30,00,000, 6 % convertible debentures of face value of
`100 per debenture at par. The debentures are redeemable at a premium of 10% on 31.03.19
or these may be converted into ordinary shares at the option of the holder, the interest rate
for equivalent debentures without conversion rights would have been 10%.

Being compound financial instrument, you are required to separate equity and debt portion
as on 01.04.15. [PM, Nov. 2009]

Solution:

Computation of Equity and Debt Component of Convertible Debentures as on 1.4.15

Present value of the principal repayable after four years 22,44,000

[30,00,000 x .680 at 10% Discount factor]
Present value of Interest 5,70,600
[1,80,000 x 3.17 (4 years cumulative 10% discount factor)]
Value of debt component 28,14,600
Value of equity component 1,85,400
Proceeds of the issue 30,00,000

Q15. Entity B places its privately held ordinary shares that are classified as equity with a stock
exchange and simultaneously raises new capital by issuing new ordinary shares on the stock
exchange.
Transaction costs are incurred in respect of both transactions. Determine the treatment of
the incurred transactions costs? [PM]
Solution
Since the issue of new shares is the issue of an equity instrument, but the placing of the
existing equity instruments with the exchange is not, the transaction costs will need to be
allocated between the two transactions.
Transaction costs in respect of the new shares issued will be recognised in equity whereas the
transaction costs incurred in placing the existing shares with the stock exchange will be
recognised in profit or loss.
Q16. An entity issues a non-redeemable callable subordinated bond with a fixed 6% coupon. The
coupon can be deferred in perpetuity at the issuer’s option. The issuer has a history of paying
the coupon each year and the current bond price is predicated on the holders expectation
that the coupon will continue to be paid each year. In addition the stated policy of the issuer
is that the coupon will be paid each year, which has been publicly communicated. Evaluate?
[PM]
Solution
Although there is both pressure on the issuer to pay the coupon, to maintain the bond price,
and a constructive obligation to pay the coupon, there is no contractual obligation to do so.
Therefore the bond is classified as an equity instrument.

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Q17. A zero coupon bond is an instrument where no interest is payable during the instrument's life
and that is normally issued at a deep discount to the value at which it will be redeemed.
Evaluate? [PM]

Solution
Although there are no mandatory periodic interest payments, the instrument provides for
mandatory redemption by the issuer for a determinable amount at a fixed or determinable
future date. Since there is a contractual obligation to deliver cash for the value at which the
bond will be redeemed, the instrument is classified as a financial liability.

Q18. XYZ ltd grants loans to its employees at 4% amounting to ` 10,00,000 at the beginning of
2015-16. The principal amount is repaid over a period of 5 years whereas the accumulated
interest computed on reducing balance at simple interest is collected in 2 equal annual
instalments after collection of the principal amount.
Assume the benchmark interest rate is 8%.
Show the accounting entries on 1-4-2015 and 31-3-2016.
Solution
Computation of Fair Value at Initial Recognition
Year Estimated Cash PVIF @8% Present Value
Flows
1/4/2015 1 Nil
31/3/2016 2,00,000 0.9259 1,85,185
31/3/2017 2,00,000 0.8573 1,71,468
31/3/2018 2,00,000 0.7938 1,58,766
31/3/2019 2,00,000 0.7350 1,47,006
31/3/2020 2,00,000 0.6806 1,36,117
31/3/2021 60,000 0.6302 37,810
See Working note
31/3/2022 60,000 0.5835 35,009
Fair Value
SeeofWorking
Loan note 8,71,361
Working Notes:
Computation of Interest to be paid on 31/3/2021 and 31/3/2022
Year Cash Flows Principal Interest Cumulative
outstanding Interest
31/3/2016 2,00,000 8,00,000 40,000 40,000
31/3/2017 2,00,000 6,00,000 32,000 72,000
31/3/2018 2,00,000 4,00,000 24,000 96,000
31/3/2019 2,00,000 2,00,000 16,000 1,12,000
31/3/2020 2,00,000 Nil 8,000 1,20,000
31/3/2021 60,000
(1,20,000/2)
31/3/2022 60,000
(1,20,000/2)

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Computation of Fair Value Loss

Fair Value of Loan 8,71,361

Loan Amount 10,00,000
Fair Value Loss 1,28,639

Journal Entry at Initial Recognition

Date Particulars Dr Cr
1/4/2015 Loans to Employee A/c 8,71,361
Employee Benefits A/c 1,28,639
10,00,000
To Bank A/c

Note: Employee benefit is transferred to Statement of Profit and Loss.

Computation of Interest on Amortised Cost

Opening Interest @ Closing
8% Repayment
Year Balance Balance
(2) (3)
(1) (1+2-3)
1/4/2015 8,71,361
31/3/2016 8,71,361 69,709 2,00,000 7,41,070
31/3/2017 7,41,070 59,286 2,00,000 6,00,356
31/3/2018 6,00,356 48,028 2,00,000 4,48,384
31/3/2019 4,48,384 35,871 2,00,000 2,84,255
31/3/2020 2,84,255 22,740 2,00,000 1,06,995
31/3/2021 1,06,995 8,560 60,000 55,555
31/3/2022 55,555 4,445 60,000 Nil

Journal Entry on 31/3/2016

Date Particulars Dr Cr
31/3/2016 Loans to Employee A/c 69,709
To Interest Accrued A/c 69,709
31/3/2016 Bank A/c 2,00,000
To Loan to Employees 2,00,000
Note: Similar entries would be done at the end of each year.

Q19. ABC Ltd. Issued Debentures amounting to ` 100 lacs.

As per the terms of the issue it has been agreed to issue equity shares amounting to ` 150
lacs to redeem the debentures at the end of 3rd year.

Assume comparable market yield is 10% for year 0 and 1, and 10.5% for Year 2 end. Show
accounting entries.
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Solution:

Value of Debentures to be recorded at initial:

Present Value of 150 lacs at 10%
= 150 lacs x PVIF (10% at the end of 3rd year)
= 150 lacs x 0.7513
= 112,69,500

Journal Entries at Inception:

Date Particulars Dr Cr
1st Year Beg Bank A/c 100,00,000
Profit & Loss A/c 12,69,500
To Debentures 112,69,500

Journal Entries at 1st Year End:

Date Particulars Dr Cr
st
1 Year End Interest A/c 11,26,950
To Debentures A/c 11,26,950
(10% of 112,69,500)

Journal Entries at 2nd Year End:

Date Particulars Dr Cr
nd
2 Year End Interest A/c 11,78,550
To Debentures A/c 11,78,550

Working Note:
Present Value of 150 lacs at 10.5% compared to Book Value
i.e. 150 lacs x 0.905 = 135,75,000 compared to 123,96,450 = 11,78,550

Journal Entries at 3rd Year End:

Date Particulars Dr Cr
3rd Year End Interest A/c 14,25,000
To Debentures A/c 14,25,000
Working Note:
Present Value of 150 lacs at 10.5% compared to Book Value
i.e. 150 lacs x 1 = 150,00,000 compared to 135,75,000 = 14,25,000

On conversion to Equity Shares

Date Particulars Dr Cr
3rd Year End Debentures A/c 150,00,000
To Equity Share Capital 100,00,000
To Securities Premium 50,00,000

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Q20. As point of staff welfare measures, Y Co. Ltd. has contracted to lend to its employees sums of
money at 5 percent per annum rate of interest. The amounts lent are to be repaid alongwith
the interest in five equal annual instalments. The market rate of interest is 10 per cent per
annum.
Y lent ` 16,00,000 to its employees on 1st January, 2015.

Following the principles of recognition and measurement as laid down in Ind AS 109, you are
required to record the entries for the year ended 31st December, 2015 for the transaction
and also calculate the value of the loan initially to be recognized and the amortized cost for
all the subsequent years.

For purposes of calculation, the following discount factors at interest rate of 10 percent may
be adopted

At the end of year [May, 2012]

1 .909
2 .827
3 .751
4 .683
5 .620

Solution

(i) Calculation of initial recognition amount of loan to employees

Cash Inflow Total P.V. Present
factor value
Year end Principal Interest @ 5%
` `
` ` @10%
2015 3,20,000 80,000 4,00,000 0.909 3,63,600
2016 3,20,000 64,000 3,84,000 0.827 3,17,568
2017 3,20,000 48,000 3,68,000 0.751 2,76,368
2018 3,20,000 32,000 3,52,000 0.683 2,40,416
2019 3,20,000Present
16,000
value or Fair3,36,000
value 0.620 2,08,320
14,06,272

(ii) Calculation of amortised cost of loan to employees

Year Amortised cost Interest to be Repayment Amortised Cost
(Closing
(Opening recognised@10% (including balance)
balance) [1] [2] interest) [3] [4]=[1]+ [2]–[3]
` ` ` `
2015 14,06,272 1,40,627 4,00,000 11,46,899
2016 11,46,899 1,14,690 3,84,000 8,77,589
2017 8,77,589 87,759 3,68,000 5,97,348
2018 5,97,348 59,735 3,52,000 3,05,083
2019 3,05,083 30,917* 3,36,000 Nil

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* ` 3,05,083 x 10% = ` 30,508. The difference of ` 409 (` 30,917 – ` 30,508) is due to

approximation in computation.

(iii) Journal Entries in the books of Y Ltd.

For the year ended 31st December, 2015 (regarding loan to employees)

Dr. Cr.
Amount (`) Amount
(`)
Staff loan A/c Dr. 16,00,000
To Bank A/c 16,00,000
(Being the disbursement of loans to staff)
Staff cost A/c ` (16,00,000 –14,06,272) [Refer part (ii])
Dr. 1,93,728
1,93,728
To Staff loan A/c
(Being the write off of excess of loan balance over
present value thereof in order to reflect the loan at its
present value of ` 14,06,272)
Staff loan A/c Dr. 1,40,627
To Interest on staff loan A/c 1,40,627
(Being the charge of interest @ market rate of 10%
on the loan)
Bank A/c Dr. 4,00,000
To Staff loan A/c 4,00,000
(Being the repayment of first instalment with interest
for the year)
Interest on staff loan A/c Dr. 1,40,627
To Profit and loss A/c 1,40,627
(Being transfer of balance of staff loan Interest
account to profit and loss account)

Q21. K Ltd. issued 5,00,000, 6% Convertible Debentures of ` 10 each on the 1st April 2015. The
debentures are due for redemption on 31st March, 2019 at a premium of 10% convertible
into equity shares to the extent of 50% and the balance to be settled in cash to the debenture
holders. The interest rate on equivalent debentures without conversion rights was 10%. You
are required to separate the debt & equity components at the time of the issue and show the
accounting entry in the company's books at initial recognition.
The following Present Values of ` 1 at 6% and at 10% are supplied to you

Interest Rate Year 1 Year 2 Year3 Year

6% 0.9 0.8 0.84 40.7
10% 0.9
4 0.8
9 0.75 0.6
9
1 3 8 [Nov. 2013]

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Solution
Computation of Debt Component of Convertible Debentures as on 1.4.2015

Particulars `
Present value of the principal repayable after four years 18,70,000
[50,00,000 x 50%× 1.10 × 0.68 (10% Discount factor)] (a)
Present value of Interest [3,00,000 x 3.17 (4 years cumulative 10% 9,51,000
discount factor)](b) 28,21,000
Total present Value of debt component (I) (a + b) Issue proceeds from 50,00,000
convertible debenture (II) 21,79,000
Value of equity component (II – I)

Journal entry at initial recognition

Dr. (`) Cr. (`)

Cash / Bank A/c Dr. 50,00,000
To 6% Debenture (Liability component) A/c 28,21,000
To 6% Debenture (Equity component) A/c 21,79,000
(Being the disbursement recorded at fair value)

Q22. Write short notes on:

(i) Disclosure of carrying amounts of financial assets and financial liabilities in Balance
Sheet
(ii) De-recognition of financial liability

Solution
(i) As per IND AS 107, carrying amounts of each of the following categories, as
defined in IND AS 32, should be disclosed either on the face of the balance sheet or in
the notes:
(a) financial assets at fair value through profit or loss, showing separately (i) those
designated as such upon initial recognition and (ii) those classified as held for
trading in accordance with IND AS 32;
(b) held-to-maturity investments;
(c) loans and receivables;
(d) available-for-sale financial assets;
(e) financial liabilities at fair value through profit or loss, showing separately (i)
those designated as such upon initial recognition and (ii) those classified as held for
trading in accordance with IND AS 32; and
(f) financial liabilities measured at amortised cost.
(ii) In accordance with IND AS 32, An entity should remove a financial liability (or a part of
a financial liability) from its balance sheet when, and only when, it is
extinguished i.e., when the obligation specified in the contract is discharged or
cancelled or expires.

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An exchange between an existing borrower and lender of debt instruments with

substantially different terms should be accounted for as an extinguishment of the
original financial liability and the recognition of a new financial liability. Similarly, a
substantial modification of the terms of an existing financial liability or a part of it
(whether or not attributable to the financial difficulty of the debtor) should be
accounted for as an extinguishment of the original financial liability and the
recognition of a new financial liability.

The difference between the carrying amount of a financial liability (or part of a
financial liability) extinguished or transferred to another party and the consideration
paid, including any non-cash assets transferred or liabilities assumed, should be
recognized in the statement of profit and loss.

Q23. Mega Ltd. issued ` 1,00,00,000 worth of 8% Debentures of face value ` 100 each on par value
basis on 1st January, 2011. These debentures are redeemable at 12% premium at the end of
2014 or exchangeable for ordinary shares of Mega Ltd. on 1:1 basis. The interest rate for
similar debentures that do not carry conversion entitlement is 12%. You are required to
calculate the value of the debt portion of the above compound financial instrument. The
present value of the rupee at the end of years 1 to 4 at 8% and 12% are supplied to you as:
8% 12%
End of year 1 0.926 0.893
End of year 2 0.857 0.797
End of year 3 0.794 0.712
End of year 4 0.735 0.636
[Nov. 2011]
Solution
Present value of Debentures redeemable in 2014 ` 71,23,200
[` 1,00,00,000 x 1.12 x 0.636]
Present value of interest on debentures
[` 8,00,000* x 3.038 (sum of 4 years discount factors @12%)] ` 24,30,400
Value of Debt component of the convertible debentures ` 95,53,600
* Interest payable on debentures every year = ` 1,00,00,000 x 8% = ` 8,00,000.

Q24. Bee Ltd., has entered into a contract by which it has the option to sell its identified
property, plant and equipment (PPE) to Axe Ltd. for ` 100 lakhs after 3 years whereas its
current market price is ` 150 lakhs. Is the put option of Bee Ltd., a financial instrument?
Explain [PM, Nov. 2011]

Solution
As per AS 31, financial instrument is any contract that gives rise to a financial asset of one
entity and a financial liability or equity instrument of another entity. In the given
case, for the purpose of the definition of financial instrument, Property, Plant and
Equipment do not qualify the definition of financial asset as per the standard.

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To asses whether the put option of BEE Ltd., is a financial instrument or not it is
necessary to evaluate the past practice of Bee Ltd. If Bee Ltd. has the past practice of settling
net, then it becomes a financial instrument.

If Bee Ltd. intends to sell the identified Property, Plant and Equipment and settle by
delivery and there is no past practice of settling net, then the contract should not be
accounted for as financial instrument under AS 30 “ Financial Instruments: Recognitions
Measurement” and AS 31 “Financial Instrument: Presentation”.

Q25. Entity ABC enters into a fixed price forward contract to purchase 50,00,000 kilograms of
copper in accordance with its expected usage requirements.
The contract permits ABC to take physical delivery of the copper at the end of 12 months or
to pay or receive a net settlement in cash, based on the change in fair value of copper. Is the
contract covered under Financial Instruments standard? [PM]

Solution

The above contract needs to be evaluated to determine whether it falls within the scope of
the financial instruments standards.
The contract is a derivative instrument because there is no initial net investment, the contract
is based on the price of copper and it is to be settled at a future date.

However, if ABC intends to settle the contract by taking delivery and has no history for similar
contracts of settling net in cash, or of taking delivery of the copper and selling it within a
short period after delivery for the purpose of generating a profit from short term fluctuations
in price or dealer's margin, the contract is not accounted for as a derivat ive under Ind AS 109.

Instead, it is accounted for as an executory contract and if it becomes onerous then Ind AS 37
would apply.

Q26. A buyer buys a stock option of New Light Company Limited on 30th August, 2006 with a strike
price of ` 150 per unit to be expired on September 30, 2006. The premium is ` 10 per unit
and the market lot is of 100. The margin to be paid is ` 60 per unit.

Show, how the transactions will appear in the books of the seller, when:
(i) The option is settled by delivery of the Asset, and
(ii) The option is settled in cash and the Index price is ` 160 per unit. [May, 2007]

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Solution
In the Books of Seller
Dr. Cr.
Amount Amount
` `
At the time of inception:
30th August Equity Stock Option Margin A/c (100 x ` 60) Dr. 6,000
To Bank A/c 6,000
(Being the initial Margin paid on option)
Bank A/c (100 x ` 10) Dr. 1,000
To Equity Stock Option Premium A/c 1,000
(Being the premium on option collected)
At the time of final settlement:
Bank A/c Dr. 6,000
To Equity Stock Option Margin A/c 6,000
(Being margin on equity stock option received
back on exercise/expiry of option).
(i) Option is settled by delivery of asset
30th September Bank A/c Dr. 15,000
To Equity Shares of New Light Ltd A/c 15,000
(Being shares delivered on exercise of option)
Equity Stock Option Premium A/c Dr. 1,000
To Profit & Loss A/c 1,000
(Being premium on option recognized as
income)
(ii) Option is settled in cash
30th September Profit & Loss A/c [(160 – 150) x 100] Dr. 1,000
To Bank A/c 1,000
(Being difference in index price and strike
price i.e. loss on exercise of option paid in
cash)
Equity Stock Option Premium A/c Dr. 1,000
To Profit & Loss A/c 1,000
(Being premium on option recognized as income)

Q27. On February 1, 2009, Future Ltd. entered into a contract with Son Ltd. to receive the fair
value of 1000 Future Ltd.’s own equity shares outstanding as on 31-01-2010 in
exchange for payment of ` 1,04,000 in cash i.e., ` 104 per share. The contract will be settled
in net cash on 31.01.2010.

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The fair value of this forward contract on the different dates were:
(i) Fair value of forward on 01-02-2009 Nil
(ii) Fair value of forward on 31-12-2009 ` 6,300
(iii) Fair value of forward on 31-01-2010 ` 2,000

Presuming that Future Ltd. closes its books on 31st December each year, pass entries:
(i) If net is settled in cash
(ii) If net is settled by Son Ltd. by delivering shares of Future Ltd. [Nov. 2010]

Solution
If net is settled in cash
(i) 1.2.2009
No entry is required because fair value of derivative is zero and no cash is paid or
received.

(`) (`)
(ii) 31.12.2009
Forward Contract (Asset) A/c Dr. 6,300
To Profit and Loss A/c 6,300
(Gain recorded due to increase in fair value of the forward contract)

(iii) 31.01.2010
Profit and Loss A/c Dr. 4,300
To Forward Contract (Asset) A/c 4,300
(Loss recorded due to decrease in fair value of the forward contract)

(iv) 31.01.2010
Cash A/c Dr. 2,000
To Forward Contract (Asset) A/c 2,000
(Being forward contract settled in cash)

If net is settled by delivery of shares First three entries will be same.

Entry no. (iv) will change as under:

Equity A/c Dr. 2,000
To Forward Contract (Asset) A/c 2,000
(Being forward contract settled by delivery of shares)

Q28. M/s TS Ltd. has entered into a contract by which it has the option to sell its specified asset to
NB Ltd. for `100 lakhs after 3 years whereas the current market price is ` 150 lakhs.
Company always settles account by delivery. What type of option is this? Is it a financial
instrument? Explain with reference to the relevant accounting standard.
[Nov., 2010]
Solution
As per AS 31 “Financial Instruments: Presentation”, a financial instrument is any contract that
gives rise to a financial asset of one entity and a financial liability or equity instrument of
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another entity. In the given case, M/s TS Ltd. has entered into a contract with NB Ltd. and
company settles its account by delivery, and does not give rise to any financial asset or
financial liability. Hence there is no option.

Since, the above transaction does not give rise to a financial asset of one entity and a
financial liability or equity instrument of another entity; this is not a financial instrument. It is
only a financial contract.

Q29. Certain callable convertible debentures are issued at ` 60. The value of similar debentures
without call or equity conversion option is ` 57. The value of call as determined using Black
and Scholes model for option pricing is ` 2. Determine values of liability and equity
component. [May, 2011]

Solution
A callable convertible debenture is one that gives the issuer a right to buy a convertible
debenture from the debentureholder at a specified price. This feature in effect is a call
option written by the debentureholder. The value of call (i.e. option premium) is payable by
the issuer.

Liability component of non-convertible debentures (disregarding the call value) = ` 57

Less: Value of call payable by the issuer = ` 2
Net liability component of non-convertible debentures = `55
Equity component in callable convertible debentures = ` 60 – ` 55 = ` 5

Q30. Adventure Limited issued 20,000, 9% convertible debentures of ` 100 each at par at the
beginning of the year. The debentures are of 6 years term. The interest will be paid half
yearly. The debenture-holders have the option to get 50% of the debentures converted into 2
ordinary shares at the end of 3rd year. The debenture holders who do not opt for conversion
will be paid 50% of their face value at the end of year 3. The balance non-convertible portion
will be repaid at 10% premium at the end of term of the debenture. At the time of issue, the
prevailing market interest rate for similar debt without convertibility option is 10%.

Present Value of annuity is as under:

Period (half yearly) 03-Jan 06-Apr 12-Jul

Annuity factor @ 10% 2.487 1.868 2.459
Annuity factor @ 5% 2.723 2.353 3.787

Present value of ` 1 at the end of 3 years at 10% and 5% is 0.565 and 0.747 respectively.
Present value of ` 1 at the end of 6 years at 10% and 5% is 0.317 and 0.557 respectively.

Compute the liability component and equity component and pass necessary journal entries
recognizing the issue of debentures. [Nov., 2014]

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Solution

Statement showing computation of equity and liability component

Cash Flow Discounting Present Value

Half-year period
` in 000s Factor (5%) ` in 000s
1–6 90 5.076* 456.84
7 – 12 45 3.787 170.415
12 1,100 0.557 612.7
Value of host (Liability component) 1,239.96
Value of embedded 760.045
derivative (Equity component)
Issue proceeds 2,000.00
* 2.723 + 2.353 = 5.076

Journal Entries
Debit Credit
Bank A/c Dr. 2,000.00
To Liability component 1,239.96
To Equity component 760.045
(Being issue of debentures recorded at fair values)

Q31. In the following situations evaluate whether the preference shares are an equity
instrument or a financial liability to the issuer entity.

Situation 1: A company has issued 6% mandatorily redeemable preference shares with

mandatory fixed dividends.

Situation 2: A company issued non-redeemable preference shares with dividend

payments linked to ordinary shares. Also state whether your answer will differ if the
dividend payments are cumulative. [May. 2016]

Solution

Situation 1: In determining whether a mandatorily redeemable preference share is a

financial liability or an equity instrument, it is necessary to examine the particular
contractual rights attaching to the instrument's principal and return components.

6% Redeemable preference shares provides for mandatory periodic fixed dividend

payments and mandatory redemption by the issuer for a fixed amount at a fixed

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future date. Since there is a contractual obligation to deliver cash (for both dividends
and repayment of principal) to the shareholder that cannot be avoided, the instrument
is a financial liability in its entirety.

Situation 2: An entity issues a non-redeemable preference shares on which dividends

are payable only if the entity also pays a dividend on its ordinary shares.

The dividend payments on the preference shares are discretionary and not contractual,
because no dividend can be paid if no dividend is paid on the ordinary shares, which are an
equity instrument. As the perpetual preference shares contain no contractual obligation
ever to pay dividend and there is no obligation to repay the principal, they should be
classified as equity in their entirety.

If the dividend payments are cumulative, that is, if no dividend is paid on the ordinary
shares, the preference dividend is deferred, the perpetual shares will be classified as
equity only if the dividend can be deferred indefinitely and the entity does not have any
contractual obligations whatsoever to pay those dividend.

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IND AS 32, 107, 109

FINANCIAL INSTRUMENTS
PRACTICALS QUESTIONS

Q.1. (Exchange of Financial Liability at Unfavourable terms)

A company borrowed ` 50 lacs @ 12% p.a. Tenure of the loan is 10 years. Interest is payable every year
and the principal is repayable at the end of 10th year. The company defaulted in payment of interest for
the year 4, 5 and 6.

A loan reschedule agreement took place at the end of 7 year. As per the agreement the company is
required to pay ` 90 lacs at the end of 8th year. Calculate the additional amount to be paid on account of
rescheduling and also the book value of loan at the end of 8th year when reschedule agreement took
place.
[MAY, 2017]
Ans.
Assumption: Interest is compounded in case of default.

Outstanding Amount at the end of 8th year = ` 50,00,000 x 1.12 x 1.12 x 1.12 x 1.12 x 1.12

= ` 88,11,708 (i.e. adding interest for 4th to 8th year) Rescheduled amount to be paid at the end of the 8th
year = ` 90,00,000
Additional amount to be paid on rescheduling = ` 90,00,000 - ` 88,11,7081 = ` 1,88,291

Q.2. Entity A holds an option to purchase equity shares in a listed entity B for ` 100 per share at the end of a 90
day period. Evaluate the contract whether a financial asset or a financial liability? What if the entity A has
written the option?
Ans.
The above call option gives entity A, a contractual right to exchange cash of ` 100 for an equity share in
another entity and will be exercised if the market value of the share exceeds `100 at the end of the 90 day
period. If the market value of a share will be such that the entity A will gain on the exercise date, it will
exercise the call option.

Since entity A stands to gain if the call option is exercised, the exchange is potentially favourable
to the entity. Therefore, the option is a derivative financial asset from the time the entity becomes a party
to the option contract.

On the other hand, if entity A writes an option under which the counterparty can force the entity to sell
equity shares in the listed entity B for ` 100 per share at any time in the next 90 days, then entity A will be
said to have a contractual obligation to exchange its equity shares to another entity for cash of ` 100 per
share on potentially unfavourable terms i.e. if the holder exercises the option, on account of the market
price per share being above the exercise price of ` 100 per share at the end of the 90 day period.

Since entity A stands to lose if the option is exercised, the exchange is potentially unfavourable and
the option is a derivative financial liability from the time the entity becomes a party to the option contract.

Q.3. (Mandatorily Redeemable Preference Shares With Mandatory Fixed Dividends)

A Company has issued 6% mandatorily redeemable preference shares with mandatory fixed dividends.
Evaluate whether such preference shares are an equity instrument or a financial liability to the issuer
entity? [PM]
Ans.
In determining whether a mandatorily redeemable preference share is a financial liability or an equity
instrument, it is necessary to examine the particular contractual rights attaching to the instrument's
principal and return components.

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 A Book on Practicals of Ind AS & AS

The instrument in this example provides for mandatory periodic fixed dividend payments and mandatory
redemption by the issuer for a fixed amount at a fixed future date. Since there is a contractual obligation
to deliver cash (for both dividends and repayment of principal) to the shareholder that cannot be avoided,
the instrument is a financial liability in its entirety.

Q.4. (Non-redeemable Preference Shares With Mandatory Fixed Dividends)

A Company issued non-redeemable preference shares with mandatory fixed dividends. Evaluate
whether such preference shares are an equity instrument or a financial liability to the issuer entity?
Ans.
When preference shares are non-redeemable, the appropriate classification is determined by the other
rights attached to them. Classification is based on an assessment of the contractual arrangement's
substance and the definitions of a financial liability and an equity instrument.

It is necessary to examine the particular contractual rights attaching to the instrument's principal
and return components. In this example, the shares are non-redeemable and thus the amount of the
principal has equity characteristics, but the entity has a contractual obligation to pay dividends that
provides the shareholders with a lender's return. This obligation is not negated if the entity is unable
to pay the dividends because of lack of funds or insufficient distributable profits. Therefore, the obligation
to pay the dividends meets the definition of a financial liability.

The overall classification is that the shares may be a compound instrument, which may require each
component to be accounted for separately. It would be a compound instrument if the coupon was initially
set at a rate other than the prevailing market rate or the terms specified payment of discretionary
dividends in addition to the fixed coupon. If the coupon on the preference shares was set at market rates
at the date of issue and there were no provisions for the payment of discretionary dividends, the entire
instrument would be classified as a financial liability, because the stream of cash flows is in perpetuity.

Q.5. (Non-redeemable Preference Shares with Dividend Payments linked to Ordinary Shares)
A company issued Non-redeemable preference shares with dividend payments linked to ordinary
shares. Evaluate whether such preference shares are an equity instrument or a financial liability to
the issuer entity?
Ans.
An entity issues a non-redeemable preference shares on which dividends are payable only if the entity also
pays a dividend on its ordinary shares.

The dividend payments on the preference shares are discretionary and not contractual, because no
dividends can be paid if no dividends are paid on the ordinary shares, which are an equity instrument. As
the perpetual preference shares contain no contractual obligation ever to pay dividends and there is
no obligation to repay the principal, they should be classified as equity in their entirety.

Where the dividend payments are also cumulative, that is, if no dividends are paid on the ordinary shares,
the preference dividends are deferred, the perpetual shares will be classified as equity only if the
dividends can be deferred indefinitely and the entity does not have any contractual obligations
whatsoever to pay those dividends.
A liability for the dividend payable would be recognised once the dividend is declared.

Q.6. Let us say on 30th March 2015 an entity enters into an agreement to purchase a Financial Asset for ` 100
which is the Fair Value on that date.
On Balance Sheet date i.e. 31/3/2015 the Fair Value is 102 and on Settlement date i.e. 2/4/2015
Fair Value is 103.
Pass necessary Journal entries on trade date and settlement date when the asset acquired is measured at
(a) Amortised cost
(b) FVTPL
(c) FVTOCI [PM]

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Ans.
Financial Asset at Amortised Cost – Trade Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 Financial Asset Dr. 100
To Payables 100
31/3/2015 No Entry
2/4/2015 Payables Dr. 100
To Cash 100

Financial Asset at Amortised Cost – Settlement Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 No Entry
No Entry
31/3/2015
2/4/2015 Financial Asset Dr. 100
To Cash 100

Financial Asset at FVTPL – Trade Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 Financial Asset Dr. 100
To Payables
100
31/3/2015 Financial Asset Dr. 2
To P&L
2
2/4/2015 Financial Asset Dr. 1
To P&L
1
Payables Dr. 100
To Cash 100

Financial Asset at FVTPL– Settlement Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 No Entry
31/3/2015 Fair Value Change Dr. 2 2
To P&L
Fair Value Change Dr. 1
2/4/2015 To P&L 1
Financial Asset Dr. 103
To Cash 100
To Fair Value Change 3

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Financial Asset at FVTOCI – Trade Date Accounting

Dates Journal Entry Amount Amount
30/3/2015 Financial Asset Dr. 100
To Payables 100
Financial Asset Dr. 2
31/3/2015 To OCI 2
Financial Asset Dr. 1
To OCI 1
2/4/2015 Payables Dr. 100
To Cash 100

Financial Asset at FVTOCI – Settlement Date Accounting

Dates Journal Entry Amount Amount

30/3/2015 No Entry
31/3/2015 Fair Value Change Dr. 2
To OCI 2
Fair Value Change Dr.
2/4/2015 To OCI 1
1
Financial Asset Dr. 103
To Cash 100
To Fair Value Change 3

Q.7. (Financial Asset Accounted as FVTPL)

A Company invested in Equity shares of another entity on 15th March for ` 10,000. Transaction
Cost = ` 200 (not included in `10,000)
Fair Value on Balance Sheet date i.e. 31st March 2015 = ` 12,000. Pass necessary Journal Entries
Ans.
Date Particulars Dr Cr
15/3/2015 Investment A/c 10,000
Transaction Cost A/c 200
To Bank 10,200

31/3/2015 Investment A/c 2,000

To Fair Value Gain A/c 2,000

31/3/2015 P&L A/c 200

To Transaction Cost A/c 200

31/3/2015 Fair Value Gain A/c 2,000

To P&L A/c 2,000

Q.8. (Financial Asset Accounted as FVTOCI)

A Company invested in Equity shares of another entity on 15th March for ` 10,000. Transaction
Cost = ` 200 (not included in ` 10,000). Fair Value on Balance Sheet date i.e. 31st March 2015 = ` 12,000.
Pass necessary Journal entries.
Ans.
Date Particulars Dr Cr
15/3/2015 Investment A/c 10,200
To Bank 10,200

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 A Book on Practicals of Ind AS & AS
31/3/2015 Investment A/c 1,800
To Fair Value Gain A/c 1,800

31/3/2015 Fair Value Gain A/c 1,800

To OCI A/c 1,800

31/3/2015 OCI A/c 1,800

To Fair Value Reserve A/c 1,800

Q.9. (Financial Asset Accounted as Amortised Cost)

A Company lends ` 100 lacs to another company @ 12% p.a. interest on 1/4/2015. It incurs ` 40,000
incremental costs for documentation.
Loan tenure = 5 years with Interest charged annually.
Fair Value of Loan = 99,40,000 (100 lacs ” 1 lac + 40,000). Pass necessary Journal entries. [PM]
Ans.
This is based on the assumption that interest rate is based on market rate of interest.
Date Particulars Dr Cr
1/4/2015 Loan A/c 100 lacs
To Bank A/c 100 lacs
1/4/2015 Loan Processing Expense A/c 40,000
To Bank A/c 40,000

1/4/2015 Loan A/c 40,000

To Loan Processing Expense A/c 40,000

Subsequent entries would be explained under subsequent measurement basis.

Q.10. An entity is about to purchase a portfolio of fixed rate assets that will be financed by fixed rate
debentures. Both financial assets and financial liabilities are subject to the same interest rate risk that
gives rise to opposite changes in fair value that tend to offset each other. Comment? [PM]
Ans.
In the absence of the fair value option, the entity may have classified the fixed rate assets as FVTOCI with
gains and losses on changes in fair value recognised in other comprehensive income and the fixed rate
debentures at amortised cost. Reporting both the assets and the liabilities at fair value through profit
and loss i.e. FVTPL corrects the measurement inconsistency and produces more relevant information.

Q.11. Sea Ltd. has lent a sum of ` 10 lakhs @ 18% per annum for 10 years. The loan had a Fair Value of `
12,23,960 at the effective interest rate of 13%. To mitigate prepayment risks but at the same time
retaining control over the loan, Sea Ltd. transferred its right to receive the Principal amount of the loan on
its maturity with interest, after retaining rights over 10% of principal and 4% interest that carries Fair
Value of ` 29,000 and ` 1,84,620 respectively. The consideration for the transaction was ` 9,90,000. The
interest component retained included a 2% fee towards collection of principal and interest that has a Fair
Value of ` 65,160. Defaults, if any, are deductible to a maximum extent of the company’s claim on Principal
portion. You are required to show the Journal Entries to record derecognition of the Loan.
[Nov. 2013, May 2017]
Ans.:
(i) Calculation of securitized component of loan
` `
Fair Value 12,23,960
Less: Principal strip receivable (fair value)
Less: Interest strip receivable (fair value) 1,19,460
Less: Value of service asset (fair value) 65,160 29,000 2,13,620
1,84,620 10,10,340

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(ii) Apportionment of carrying amount in the ratio of fair values

Fair value Apportionment
(`) (`)
Securitized component of loan 10,10,340 × 10,00,000
10,10,340 12,23,960 8,25,468
Principal strip receivable 29,000 × 10,00,000
29,000 12,23,960 23,694
Interest strip receivable 1,19,460 × 10,00,000
1,19,460 12,23,960 97,601
Servicing asset 65,160 × 10,00,000
65,160 12,23,960 53,237

(iii) Entries to record the derecognition of the Loan

` ` `
Bank A/c Dr. 9,90,000
To Loan A/c 8,25,468
To Profit & Loss A/c 1,64,532
(Being entry for securitization of 90% principal with 14%
interest)
Interest strip A/c Dr. 97,601
Servicing asset A/c Dr. 53,237
Principal strip A/c Dr. 23,694
To Loan A/c 1,74,532
(Being entry for interest, servicing asset and principal
strips received)

Q.12. (Factoring with / without recourse)

Entity A (the transferor) holds a portfolio of receivables with a carrying value of ` 1,000,000. It enters into
a factoring arrangement with entity B (the transferee) under which it transfers the portfolio to entity B in
exchange for ` 900,000 of cash.

Entity B will service the loans after their transfer and debtors will pay amounts due directly to entity B.
Entity A has no obligations whatsoever to repay any sums received from the factor and has no rights to any
additional sums regardless of the timing or the level of collection from the underlying debts. Comment.
[PM]
Ans.
Entity A has transferred its rights to receive the cash flows from the asset via an assignment to entity B.
Furthermore, as entity B has no recourse to entity A for either late payment risk or credit risk, entity A has
transferred substantially all the risks and rewards of ownership of the portfolio.

Hence, entity A derecognises the entire portfolio. The difference between the carrying value of `
1,000,000 and cash received of ` 900,000 i.e. ` 100,000 is recognised immediately as a financing cost in
profit or loss.
Had Entity A not transferred its rights to receive the cash flows from the asset or there would have been
any credit default guarantee given by entity A, then it would have not led to complete transfer of
risk and rewards and entity A could not derecognise the portfolio due to the same.

Q.13. Entity XYZ enters into a fixed price forward contract to purchase 10,00,000 kilograms of copper in
accordance with its expected usage requirements.

The contract permits XYZ to take physical delivery of the copper at the end of 12 months or to pay or
receive a net settlement in cash, based on the change in fair value of copper. Is the contract covered under
Financial Instruments standard?

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Ans.
The above contract needs to be evaluated to determine whether it falls within the scope of the financial
instruments standards.

The contract is a derivative instrument because there is no initial net investment, the contract is based on
the price of copper and it is to be settled at a future date.

However, if XYZ intends to settle the contract by taking delivery and has no history for similar contracts of
settling net in cash, or of taking delivery of the copper and selling it within a short period after delivery for
the purpose of generating a profit from short term fluctuations in price or dealer's margin, the contract is
not accounted for as a derivative under Ind AS 109.

Instead, it is accounted for as an executory contract and if it becomes onerous then Ind AS 37 would apply.

Q.14. On 1 April, 2015, Delta Ltd. issued ` 30,00,000, 6 % convertible debentures of face value of `100 per
debenture at par. The debentures are redeemable at a premium of 10% on 31.03.19 or these may be
converted into ordinary shares at the option of the holder, the interest rate for equivalent debentures
without conversion rights would have been 10%.

Being compound financial instrument, you are required to separate equity and debt portion as on
01.04.15. [PM, Nov. 2009]
Ans.:
Computation of Equity and Debt Component of Convertible Debentures as on 1.4.15

Present value of the principal repayable after four years 22,44,000

[30,00,000 x .680 at 10% Discount factor]
Present value of Interest 5,70,600
[1,80,000 x 3.17 (4 years cumulative 10% discount factor)]
Value of debt component 28,14,600
Value of equity component 1,85,400
Proceeds of the issue 30,00,000

Q.15. Entity B places its privately held ordinary shares that are classified as equity with a stock exchange and
simultaneously raises new capital by issuing new ordinary shares on the stock exchange.
Transaction costs are incurred in respect of both transactions. Determine the treatment of the incurred
transactions costs? [PM]
Ans.
Since the issue of new shares is the issue of an equity instrument, but the placing of the existing equity
instruments with the exchange is not, the transaction costs will need to be allocated between the two
transactions.
Transaction costs in respect of the new shares issued will be recognised in equity whereas the transaction
costs incurred in placing the existing shares with the stock exchange will be recognised in profit or loss.

Q.16. An entity issues a non-redeemable callable subordinated bond with a fixed 6% coupon. The coupon can be
deferred in perpetuity at the issuer’s option. The issuer has a history of paying the coupon each year and
the current bond price is predicated on the holders expectation that the coupon will continue to be paid
each year. In addition the stated policy of the issuer is that the coupon will be paid each year, which has
been publicly communicated. Evaluate? [PM]
Ans.
Although there is both pressure on the issuer to pay the coupon, to maintain the bond price, and a
constructive obligation to pay the coupon, there is no contractual obligation to do so. Therefore the bond
is classified as an equity instrument.

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Q.17. A zero coupon bond is an instrument where no interest is payable during the instrument's life and that is
normally issued at a deep discount to the value at which it will be redeemed. Evaluate? [PM]
Ans.
Although there are no mandatory periodic interest payments, the instrument provides for mandatory
redemption by the issuer for a determinable amount at a fixed or determinable future date. Since there is
a contractual obligation to deliver cash for the value at which the bond will be redeemed, the instrument is
classified as a financial liability.

Q.18. XYZ ltd grants loans to its employees at 4% amounting to ` 10,00,000 at the beginning of 2015-16. The
principal amount is repaid over a period of 5 years whereas the accumulated interest computed on
reducing balance at simple interest is collected in 2 equal annual instalments after collection of the
principal amount.
Assume the benchmark interest rate is 8%.
Show the accounting entries on 1-4-2015 and 31-3-2016.
Ans.
Computation of Fair Value at Initial Recognition
Year Estimated Cash PVIF @8% Present Value
Flows

1/4/2015 1 Nil
31/3/2016 2,00,000 0.9259 1,85,185
31/3/2017 2,00,000 0.8573 1,71,468
31/3/2018 2,00,000 0.7938 1,58,766
31/3/2019 2,00,000 0.7350 1,47,006
31/3/2020 2,00,000 0.6806 1,36,117
31/3/2021 60,000 0.6302 37,810
See Working note
31/3/2022 60,000 0.5835 35,009
Fair Value of Loan See Working note 8,71,361
Working Notes:
Computation of Interest to be paid on 31/3/2021 and 31/3/2022
Year Cash Flows Principal Interest Cumulative
outstanding Interest
31/3/2016 2,00,000 8,00,000 40,000 40,000
31/3/2017 2,00,000 6,00,000 32,000 72,000
31/3/2018 2,00,000 4,00,000 24,000 96,000
31/3/2019 2,00,000 2,00,000 16,000 1,12,000
31/3/2020 2,00,000 Nil 8,000 1,20,000
31/3/2021 60,000
(1,20,000/2)
31/3/2022 60,000
(1,20,000/2)

Computation of Fair Value Loss

Fair Value of Loan 8,71,361
Loan Amount 10,00,000
Fair Value Loss 1,28,639

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Journal Entry at Initial Recognition
Date Particulars Dr Cr
1/4/2015 Loans to Employee A/c 8,71,361
Employee Benefits A/c 1,28,639
To Bank A/c 10,00,000
Note: Employee benefit is transferred to Statement of Profit and Loss.

Computation of Interest on Amortised Cost

Opening Interest @ Closing
Repayment
Year Balance 8% Balance
(3)
(1) (2) (1+2-3)
1/4/2015 8,71,361
31/3/2016 8,71,361 69,709 2,00,000 7,41,070
31/3/2017 7,41,070 59,286 2,00,000 6,00,356
31/3/2018 6,00,356 48,028 2,00,000 4,48,384
31/3/2019 4,48,384 35,871 2,00,000 2,84,255
31/3/2020 2,84,255 22,740 2,00,000 1,06,995
31/3/2021 1,06,995 8,560 60,000 55,555
31/3/2022 55,555 4,445 60,000 Nil

Journal Entry on 31/3/2016

Date Particulars Dr Cr
31/3/2016 Loans to Employee A/c 69,709
To Interest Accrued A/c 69,709

31/3/2016 Bank A/c 2,00,000

To Loan to Employees
2,00,000
Note: Similar entries would be done at the end of each year.

Q.19. ABC Ltd. Issued Debentures amounting to ` 100 lacs.

As per the terms of the issue it has been agreed to issue equity shares amounting to ` 150 lacs to redeem
the debentures at the end of 3rd year.
Assume comparable market yield is 10% for year 0 and 1, and 10.5% for Year 2 end. Show accounting
entries.
Ans.:
Value of Debentures to be recorded at initial:
Present Value of 150 lacs at 10%
= 150 lacs x PVIF (10% at the end of 3rd year)
= 150 lacs x 0.7513
= 112,69,500

Journal Entries at Inception:

Date Particulars Dr Cr
st
1 Year Beg Bank A/c 100,00,000
Profit & Loss A/c 12,69,500
To Debentures 112,69,500

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Journal Entries at 1st Year End:

Date Particulars Dr Cr
st
1 Year End Interest A/c 11,26,950
To Debentures A/c 11,26,950
(10% of 112,69,500)

Journal Entries at 2nd Year End:

Date Particulars Dr Cr
nd
2 Year End Interest A/c 11,78,550
To Debentures A/c 11,78,550

Working Note:
Present Value of 150 lacs at 10.5% compared to Book Value
i.e. 150 lacs x 0.905 = 135,75,000 compared to 123,96,450 = 11,78,550

Journal Entries at 3rd Year End:

Date Particulars Dr Cr
3 rd Year End Interest A/c 14,25,000
To Debentures A/c 14,25,000

Working Note:
Present Value of 150 lacs at 10.5% compared to Book Value
i.e. 150 lacs x 1 = 150,00,000 compared to 135,75,000 = 14,25,000

On conversion to Equity Shares

Date Particulars Dr Cr
3rd Year End Debentures A/c 150,00,000
To Equity Share Capital 100,00,000
To Securities Premium 50,00,000

Q.20. As point of staff welfare measures, Y Co. Ltd. has contracted to lend to its employees sums of money at 5
percent per annum rate of interest. The amounts lent are to be repaid alongwith the interest in five equal
annual instalments. The market rate of interest is 10 per cent per annum.
Y lent ` 16,00,000 to its employees on 1st January, 2015.

Following the principles of recognition and measurement as laid down in Ind AS 109, you are required to
record the entries for the year ended 31st December, 2015 for the transaction and also calculate the value
of the loan initially to be recognized and the amortized cost for all the subsequent years.

For purposes of calculation, the following discount factors at interest rate of 10 percent may be adopted
At the end of year [May, 2012]
1 .909
2 .827
3 .751
4 .683
5 .620

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Ans.
(i) Calculation of initial recognition amount of loan to employees
Cash Inflow P.V. Present
Year end Principal Interest @ 5% Total factor value
` @10% `
` `
2015 3,20,000 80,000 4,00,000 0.909 3,63,600
2016 3,20,000 64,000 3,84,000 0.827 3,17,568
2017 3,20,000 48,000 3,68,000 0.751 2,76,368
2018 3,20,000 32,000 3,52,000 0.683 2,40,416
2019 3,20,000 16,000 3,36,000 0.620 2,08,320

Present value or Fair value 14,06,272

(ii) Calculation of amortised cost of loan to employees

Year Amortised cost Interest to be Repayment Amortised Cost
(Opening balance) recognised@10% (including (Closing balance)
[1] [2] interest) [3] [4]=[1]+ [2]–[3]
` ` ` `
2015 14,06,272 1,40,627 4,00,000 11,46,899
2016 11,46,899 1,14,690 3,84,000 8,77,589
2017 8,77,589 87,759 3,68,000 5,97,348
2018 5,97,348 59,735 3,52,000 3,05,083
2019 3,05,083 30,917* 3,36,000 Nil
* ` 3,05,083 x 10% = ` 30,508. The difference of ` 409 (` 30,917 ” ` 30,508) is due to approximation
in computation.

(iii) Journal Entries in the books of Y Ltd.

For the year ended 31st December, 2015 (regarding loan to employees)
Dr. Amount Cr. Amount
(`) (`)
Staff loan A/c Dr. 16,00,000
To Bank A/c 16,00,000
(Being the disbursement of loans to staff)
Staff cost A/c ` (16,00,000 ”14,06,272) [Refer part (ii]) Dr. 1,93,728
To Staff loan A/c 1,93,728
(Being the write off of excess of loan balance over present
value thereof in order to reflect the loan at its present value of `
14,06,272)
Staff loan A/c Dr. 1,40,627
To Interest on staff loan A/c 1,40,627
(Being the charge of interest @ market rate of 10% on the
loan)
Bank A/c Dr. 4,00,000
To Staff loan A/c 4,00,000
(Being the repayment of first instalment with interest for the
year)
Interest on staff loan A/c Dr. 1,40,627
To Profit and loss A/c 1,40,627
(Being transfer of balance of staff loan Interest account to
profit and loss account)

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Q.21. K Ltd. issued 5,00,000, 6% Convertible Debentures of ` 10 each on the 1st April 2015. The debentures are
due for redemption on 31st March, 2019 at a premium of 10% convertible into equity shares to the extent
of 50% and the balance to be settled in cash to the debenture holders. The interest rate on equivalent
debentures without conversion rights was 10%. You are required to separate the debt & equity
components at the time of the issue and show the accounting entry in the company's books at initial
recognition.
The following Present Values of ` 1 at 6% and at 10% are supplied to you

Interest Rate Year 1 Year 2 Year3 Year 4

6% 0.94 0.89 0.84 0.79
10% 0.91 0.83 0.75 0.68
[Nov. 2013]
Ans.
Computation of Debt Component of Convertible Debentures as on 1.4.2015

Particulars `
Present value of the principal repayable after four years 18,70,000
[50,00,000 x 50%× 1.10 × 0.68 (10% Discount factor)] (a)
Present value of Interest [3,00,000 x 3.17 (4 years cumulative 10%
discount factor)](b) 9,51,000
Total present Value of debt component (I) (a + b) Issue proceeds from convertible 28,21,000
debenture (II) 50,00,000
Value of equity component (II ” I) 21,79,000

Journal entry at initial recognition

Dr. (`) Cr. (`)
Cash / Bank A/c Dr. 50,00,000
To 6% Debenture (Liability component) A/c 28,21,000
To 6% Debenture (Equity component) A/c 21,79,000
(Being the disbursement recorded at fair value)

Q.22. Write short notes on:

(i) Disclosure of carrying amounts of financial assets and financial liabilities in Balance Sheet
(ii) De-recognition of financial liability
Ans.
(i) As per IND AS 107, carrying amounts of each of the following categories, as defined in IND
AS 32, should be disclosed either on the face of the balance sheet or in the notes:
(a) financial assets at fair value through profit or loss, showing separately (i) those designated
as such upon initial recognition and (ii) those classified as held for trading in accordance with
IND AS 32;
(b) held-to-maturity investments;
(c) loans and receivables;
(d) available-for-sale financial assets;
(e) financial liabilities at fair value through profit or loss, showing separately (i) those
designated as such upon initial recognition and (ii) those classified as held for trading in
accordance with IND AS 32; and
(f) financial liabilities measured at amortised cost.

(ii) In accordance with IND AS 32, An entity should remove a financial liability (or a part of a financial
liability) from its balance sheet when, and only when, it is extinguished i.e., when the
obligation specified in the contract is discharged or cancelled or expires.
An exchange between an existing borrower and lender of debt instruments with substantially
different terms should be accounted for as an extinguishment of the original financial liability and
the recognition of a new financial liability. Similarly, a substantial modification of the terms of an

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existing financial liability or a part of it (whether or not attributable to the financial difficulty of the
debtor) should be accounted for as an extinguishment of the original financial liability and the
recognition of a new financial liability.

The difference between the carrying amount of a financial liability (or part of a financial liability)
extinguished or transferred to another party and the consideration paid, including any non-cash
assets transferred or liabilities assumed, should be recognized in the statement of profit and loss.

Q.23. Mega Ltd. issued ` 1,00,00,000 worth of 8% Debentures of face value ` 100 each on par value basis on 1st
January, 2011. These debentures are redeemable at 12% premium at the end of 2014 or exchangeable
for ordinary shares of Mega Ltd. on 1:1 basis. The interest rate for similar debentures that do not carry
conversion entitlement is 12%. You are required to calculate the value of the debt portion of the above
compound financial instrument. The present value of the rupee at the end of years 1 to 4 at 8% and 12%
are supplied to you as:
8% 12%
End of year 1 0.926 0.893
End of year 2 0.857 0.797
End of year 3 0.794 0.712
End of year 4 0.735 0.636
[Nov. 2011]
Ans.
Present value of Debentures redeemable in 2014 ` 71,23,200
[` 1,00,00,000 x 1.12 x 0.636]
Present value of interest on debentures
[` 8,00,000* x 3.038 (sum of 4 years discount factors @12%)] ` 24,30,400
Value of Debt component of the convertible debentures ` 95,53,600
* Interest payable on debentures every year = ` 1,00,00,000 x 8% = ` 8,00,000.

Q.24. Bee Ltd., has entered into a contract by which it has the option to sell its identified property, plant
and equipment (PPE) to Axe Ltd. for ` 100 lakhs after 3 years whereas its current market price is ` 150
lakhs. Is the put option of Bee Ltd., a financial instrument? Explain [PM, Nov. 2011]
Ans.
As per AS 31, financial instrument is any contract that gives rise to a financial asset of one entity and
a financial liability or equity instrument of another entity. In the given case, for the purpose of
the definition of financial instrument, Property, Plant and Equipment do not qualify the definition of
financial asset as per the standard.

To asses whether the put option of BEE Ltd., is a financial instrument or not it is necessary to
evaluate the past practice of Bee Ltd. If Bee Ltd. has the past practice of settling net, then it becomes a
financial instrument.

If Bee Ltd. intends to sell the identified Property, Plant and Equipment and settle by delivery and
there is no past practice of settling net, then the contract should not be accounted for as financial
instrument under AS 30 ‚ Financial Instruments: Recognitions Measurement‛ and AS 31 ‚Financial
Instrument: Presentation‛.

Q.25. Entity ABC enters into a fixed price forward contract to purchase 50,00,000 kilograms of copper in
accordance with its expected usage requirements.

The contract permits ABC to take physical delivery of the copper at the end of 12 months or to pay or
receive a net settlement in cash, based on the change in fair value of copper. Is the contract covered under
Financial Instruments standard? [PM]

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Ans.
The above contract needs to be evaluated to determine whether it falls within the scope of the financial
instruments standards.
The contract is a derivative instrument because there is no initial net investment, the contract is based on
the price of copper and it is to be settled at a future date.
However, if ABC intends to settle the contract by taking delivery and has no history for similar contracts of
settling net in cash, or of taking delivery of the copper and selling it within a short period after delivery for
the purpose of generating a profit from short term fluctuations in price or dealer's margin, the contract is
not accounted for as a derivat ive under Ind AS 109.

Instead, it is accounted for as an executory contract and if it becomes onerous then Ind AS 37 would apply.

Q.26. A buyer buys a stock option of New Light Company Limited on 30th August, 2006 with a strike price of `
150 per unit to be expired on September 30, 2006. The premium is ` 10 per unit and the market lot is of
100. The margin to be paid is ` 60 per unit.

Show, how the transactions will appear in the books of the seller, when:
(i) The option is settled by delivery of the Asset, and
(ii) The option is settled in cash and the Index price is ` 160 per unit. [May, 2007]
Ans.
In the Books of Seller
Dr. Cr.
Amount Amount
` `
At the time of inception:

30th August Equity Stock Option Margin A/c (100 x ` 60) Dr. 6,000
To Bank A/c 6,000
(Being the initial Margin paid on option)

Bank A/c (100 x ` 10) Dr. 1,000

To Equity Stock Option Premium A/c 1,000
(Being the premium on option collected)

At the time of final settlement:

Bank A/c Dr. 6,000
To Equity Stock Option Margin A/c 6,000

(Being margin on equity stock option received back on

exercise/expiry of option).

(i) Option is settled by delivery of asset

30th September Bank A/c Dr. 15,000
To Equity Shares of New Light Ltd A/c
15,000
(Being shares delivered on exercise of option)

Equity Stock Option Premium A/c Dr. 1,000

To Profit & Loss A/c 1,000
(Being premium on option recognized as income)
(ii) Option is settled in cash
30th September Profit & Loss A/c [(160 ” 150) x 100] Dr. 1,000
To Bank A/c 1,000
(Being difference in index price and strike price i.e.
loss on exercise of option paid in cash)

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Equity Stock Option Premium A/c Dr. 1,000
To Profit & Loss A/c 1,000
(Being premium on option recognized as income)

Q.27. On February 1, 2009, Future Ltd. entered into a contract with Son Ltd. to receive the fair value of 1000
Future Ltd.’s own equity shares outstanding as on 31-01-2010 in exchange for payment of ` 1,04,000
in cash i.e., ` 104 per share. The contract will be settled in net cash on 31.01.2010.

The fair value of this forward contract on the different dates were:
(i) Fair value of forward on 01-02-2009 Nil
(ii) Fair value of forward on 31-12-2009 ` 6,300
(iii) Fair value of forward on 31-01-2010 ` 2,000

Presuming that Future Ltd. closes its books on 31st December each year, pass entries:
(i) If net is settled in cash
(ii) If net is settled by Son Ltd. by delivering shares of Future Ltd. [Nov. 2010]

Ans.
If net is settled in cash
(i) 1.2.2009
No entry is required because fair value of derivative is zero and no cash is paid or received.

(`) (`)
(ii) 31.12.2009
Forward Contract (Asset) A/c Dr. 6,300
To Profit and Loss A/c 6,300
(Gain recorded due to increase in fair value of the forward contract)

(iii) 31.01.2010
Profit and Loss A/c Dr. 4,300
To Forward Contract (Asset) A/c 4,300
(Loss recorded due to decrease in fair value of the forward contract)

(iv) 31.01.2010
Cash A/c Dr. 2,000
To Forward Contract (Asset) A/c 2,000
(Being forward contract settled in cash)

If net is settled by delivery of shares First three entries will be same.

Entry no. (iv) will change as under:

Equity A/c Dr. 2,000
To Forward Contract (Asset) A/c 2,000
(Being forward contract settled by delivery of shares)

Q.28. M/s TS Ltd. has entered into a contract by which it has the option to sell its specified asset to NB Ltd. for
`100 lakhs after 3 years whereas the current market price is ` 150 lakhs. Company always settles
account by delivery. What type of option is this? Is it a financial instrument? Explain with reference to
the relevant accounting standard. [Nov., 2010]
Ans.
As per AS 31 ‚Financial Instruments: Presentation‛, a financial instrument is any contract that gives rise to
a financial asset of one entity and a financial liability or equity instrument of another entity. In the given

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case, M/s TS Ltd. has entered into a contract with NB Ltd. and company settles its account by delivery,
and does not give rise to any financial asset or financial liability. Hence there is no option.

Since, the above transaction does not give rise to a financial asset of one entity and a financial
liability or equity instrument of another entity; this is not a financial instrument. It is only a financial
contract.

Q.29. Certain callable convertible debentures are issued at ` 60. The value of similar debentures without call or
equity conversion option is ` 57. The value of call as determined using Black and Scholes model for
option pricing is ` 2. Determine values of liability and equity component. [May, 2011]
Ans.
A callable convertible debenture is one that gives the issuer a right to buy a convertible debenture
from the debentureholder at a specified price. This feature in effect is a call option written by the
debentureholder. The value of call (i.e. option premium) is payable by the issuer.

Liability component of non-convertible debentures (disregarding the call value) = ` 57

Less: Value of call payable by the issuer = ` 2
Net liability component of non-convertible debentures = `55
Equity component in callable convertible debentures = ` 60 ” ` 55 = ` 5

Q.30. Adventure Limited issued 20,000, 9% convertible debentures of ` 100 each at par at the beginning of the
year. The debentures are of 6 years term. The interest will be paid half yearly. The debenture-holders
have the option to get 50% of the debentures converted into 2 ordinary shares at the end of 3rd year. The
debenture holders who do not opt for conversion will be paid 50% of their face value at the end of year 3.
The balance non-convertible portion will be repaid at 10% premium at the end of term of the debenture.
At the time of issue, the prevailing market interest rate for similar debt without convertibility option is
10%.

Present Value of annuity is as under:

Period (half yearly) 03-Jan 06-Apr 12-Jul

Annuity factor @ 10% 2.487 1.868 2.459
Annuity factor @ 5% 2.723 2.353 3.787

Present value of ` 1 at the end of 3 years at 10% and 5% is 0.565 and 0.747 respectively. Present value of `
1 at the end of 6 years at 10% and 5% is 0.317 and 0.557 respectively.

Compute the liability component and equity component and pass necessary journal entries recognizing the
issue of debentures. [Nov., 2014]
Ans.
Statement showing computation of equity and liability component

Cash Flow Discounting Present Value

Half-year period
` in 000s Factor (5%) ` in 000s
1”6 90 5.076* 456.84
7 ” 12 45 3.787 170.415
12 1,100 0.557 612.7
Value of host (Liability component) 1,239.96
Value of embedded derivative 760.045
(Equity component)
Issue proceeds 2,000.00
* 2.723 + 2.353 = 5.076

First in India – Ind AS Solution – By CA SARTHAK JAIN 159

 A Book on Practicals of Ind AS & AS
Journal Entries
Debit Credit
Bank A/c Dr. 2,000.00
To Liability component 1,239.96
To Equity component 760.045
(Being issue of debentures recorded at fair values)

Q.31. In the following situations evaluate whether the preference shares are an equity instrument or a
financial liability to the issuer entity.

Situation 1: A company has issued 6% mandatorily redeemable preference shares with mandatory fixed
dividends.

Situation 2: A company issued non-redeemable preference shares with dividend payments linked to
ordinary shares. Also state whether your answer will differ if the dividend payments are cumulative.
[May. 2016]
Ans.
Situation 1: In determining whether a mandatorily redeemable preference share is a financial
liability or an equity instrument, it is necessary to examine the particular contractual rights attaching
to the instrument's principal and return components.
6% Redeemable preference shares provides for mandatory periodic fixed dividend payments and
mandatory redemption by the issuer for a fixed amount at a fixed future date. Since there is a
contractual obligation to deliver cash (for both dividends and repayment of principal) to the
shareholder that cannot be avoided, the instrument is a financial liability in its entirety.

Situation 2: An entity issues a non-redeemable preference shares on which dividends are payable
only if the entity also pays a dividend on its ordinary shares.
The dividend payments on the preference shares are discretionary and not contractual, because no
dividend can be paid if no dividend is paid on the ordinary shares, which are an equity instrument. As the
perpetual preference shares contain no contractual obligation ever to pay dividend and there is no
obligation to repay the principal, they should be classified as equity in their entirety.
If the dividend payments are cumulative, that is, if no dividend is paid on the ordinary shares, the
preference dividend is deferred, the perpetual shares will be classified as equity only if the dividend
can be deferred indefinitely and the entity does not have any contractual obligations whatsoever to pay
those dividend.

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160 First in India – Ind AS Solution – By CA SARTHAK JAIN